What’s an Expense Ratio?

After reviewing which posts were popular on my site last week, I noticed that starting an IRA was number one. I think one deterrent for people investing is the terminology associated with that. I decided to help out by putting out some quick posts demystifying financial lingo. Today’s term is expense ratio.

What are expense ratios?

What is the actual definition of an expense ratio? Here’s how Google defines it:

  • The percentage of a fund’s assets that are used to pay its annual expenses.
  • The percentage of total investment that shareholders pay annually for mutual fund management fees and operating expenses.
  • A comparison of the costs of owning and operating something to its potential gross income.
  • What does that mean for me as an investor?

    This percentage is taken back by the fund as a compensation for running the fund. It covers operations and management fees. Motley Fool points out that this money comes out of your return. Another interesting point that the Fool.com site brought up:

    Because the average large-cap value fund charges 1.17% more than the index, it has to outperform by at least that much to create value for investors — and more (maybe a lot more) if sales charges are involved. That’s a high hurdle for fund managers, many of whom trip and injure their clients’ portfolios in the process.

    What’s a good expense ratio to look for?

    In generally it appears that lower is better, but you have to factor it the performance of your fund. After all what good is a lower expense ratio if your fund does poorly?

    Where can I find out more information on mutual funds and investing?

    There are a lot of sites that have financial information. Try exploring and seeing which appeals to you personally. I recommend these:

    Photo Credit:  Aaron Edwards
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    6 Responses to What’s an Expense Ratio?

    1. I aim to keep my weighted average expense ratio for all funds at 0.5% or lower. Right now I’m at 0.48%. You can enter your portfolio for free at Morningstar and it will give you the weighted average for all your funds. And remember that the expense ratio does not include the fund’s fees for buying and selling stocks. To get this information, you need to look at the fund’s Statement of Additional Information, which you can find on the fund’s website.

    2. I did some calculation a while back and found that after 30 years, a portfolio invested at 0.5% expense ratio will be worth about 16% more than the one invested at 1% ER — assuming they both have the same return rate before ER.