Understanding the Expense Ratio and How It Affects Your Investments

When it comes to anything in life, you don’t want to pay more for anything if you don’t have to. Not wanting to pay for anything you don’t have to is also true with investing. You want to maximize the return on any investment you have.

You might think that means finding the investment with the best returns. High returns are certainly an eye-catching statistic. They are a significant factor when deciding where to invest your money. However, there is a bit more to it. The flip side of it is how much its costs you to invest in any particular fund. That’s where the expense ratio comes in.

What is an Expense Ratio? An expense ratio can most easily be defined as the cost for a fund to operate vs. its assets’ total value. Think of any fund as a business.

Why Are Expense Ratios Important? Knowing the fees associated with anything you’re paying for is essential, and investing is no different. When you invest in a fund with a higher expense ratio, the returns you earn are lowered by that much more.

How do I Know a Funds’ Expense Ratio? Another way to find the expense ratio is to find the fund’s prospectus. A prospectus is an overview of a fund’s investments. It needs to be filed with the SEC and sent to investors each year. Within this, you’ll find a section about any fees associated with the fund.

Can You Avoid Expense Ratios? Any fund you invest in will have operating expenses, so no, if you are a mutual fund investor, you can’t avoid them. Don’t let it deter you, as other investment choices will have costs associated with them as well. However, what you can do is find funds with relatively low costs associated with them.

Which Investment Strategy Should I Use? Your investment strategy comes down to how active or passive you want to get with your investments. Over the long haul, actively managed funds don’t typically outperform index funds. With the higher fees involved and similar returns, passive investing make sense for most of us.

A fund’s expense ratios help us understand the costs of investing in any particular mutual fund or ETF. Actively managed mutual funds need to cover their expenses. The fees and expenses typically get passed onto the investor in the form of expense ratios.

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