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Fees And Holding Period.

1/17/2013

Usually retail investor pays significant brokerage fees to trade, while some ETF charges quite modest fees. I compared both fees (see the table below) with simple assumptions - ETF can be traded for free (valid for some funds in some brokerages), annual increase of stock or ETF price is 10%, no taxes on capital gains and dividends, initial ETF fees is 0.05% from investment value while flat brokerage fees are equal 0.2% for initial purchase. Last two numbers are real, for example, Vanguard's fees is 0.05% for VOO and Scottrade charges flat 7$ for a trade (I assume $3,500 investment, so it is 0.2%. If you're lucky and got ten-bagger you pay 0.02% when you sell it).

Year ETF Fees /Annual ETF Fees /Cumulative Capital Gains Broker Fees/1way Broker Fees/Round trip
1 0.05% 0.05% 1.000 0.20% 0.40%
2 0.055% 0.11% 1.100 0.18% 0.38%
3 0.061% 0.17% 1.210 0.17% 0.37%
4 0.067% 0.23% 1.331 0.15% 0.35%
5 0.073% 0.31% 1.464 0.14% 0.34%
6 0.081% 0.39% 1.611 0.12% 0.32%
7 0.089% 0.47% 1.772 0.11% 0.31%
8 0.097% 0.57% 1.949 0.10% 0.30%
9 0.107% 0.68% 2.144 0.09% 0.29%
10 0.118% 0.80% 2.358 0.08% 0.28%
11 0.130% 0.93% 2.594 0.08% 0.28%
12 0.143% 1.07% 2.853 0.07% 0.27%
13 0.157% 1.23% 3.138 0.06% 0.26%
14 0.173% 1.40% 3.452 0.06% 0.26%
15 0.190% 1.59% 3.797 0.05% 0.25%
16 0.209% 1.80% 4.177 0.05% 0.25%
17 0.230% 2.03% 4.595 0.04% 0.24%
18 0.253% 2.28% 5.054 0.04% 0.24%
19 0.278% 2.56% 5.560 0.04% 0.24%
20 0.306% 2.86% 6.116 0.03% 0.23%
Click to enlarge

As anybody can see ETF fees are smaller than brokerage fees during first 5 years and after it brokerage fees for round trip are smaller when cumulative ETF fees. Therefore a long-term retail investor can "beat" even cheap ETF if (s)he hold stock long enough.

For more rigorous but a bit outdated study see

[1] Direct vs. Indirect Diversification
Keith V. Smith, John C. Schreiner
Financial Analysts Journal, Vol. 26, No. 5 (Sep. - Oct., 1970), pp. 33-38