Don't Sweat ETF Fees

Instead, the large-cap domestic funds mentioned above have notably different profiles in terms of sector balance, expected earnings growth, historical profitability of constituent firms and valuation measures such as the price-to-earnings ratio and price-to-book value, despite targeting the same category.

It is these differences, not fees or past performance, that are likely to determine how the funds perform in the future.

Critics will argue that fees for some ETFs are much higher, and therefore hardly insignificant. The popular iShares MSCI Emerging Markets fund (EEM Quote), for example, has an annual fee of 75 basis points, which, while far cheaper than the average emerging-markets mutual fund, is not something to be ignored.

True enough. And in fact, my own firm's ETF rating system, which tries to measure an ETF's investment merit, does take fees into account for the sake of accuracy. But that still misses the point. iShares MSCI Emerging Markets fund may or may not turn out to be a good investment going forward, but the answer to that question is unlikely to be determined by fees.

The difference in returns between EEM and iShares MSCI EAFE fund (EFA Quote) of developed-market foreign stocks, with a fee of 35 basis points, is most likely going to be far larger than 40 basis points per year.

For ETFs, fund fees often amount to a rounding error. So the obsession many industry analysts and investors have with fees focuses on the wrong question.

Instead of a race to the find the lowest expense ratios, investors need to try to answer the far more important question of whether the basket of stocks held by the ETF offers attractive investment potential. The answer to that question is going to determine an ETF's ultimate performance.