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. Employees need salaries, rent for the office needs to get paid, utility bills to pay, office supplies to buy, and just general costs of doing business.
A mutual fund is no different. There are people actively working behind the scenes doing all sorts of research, making trades, working through legal formalities, and various other tasks. These management fees and operation costs get passed on to you, the shareholder.
If the police officer tells you to put your hands on the steering wheel, place your hands on the wheel and keep them there until they tell you otherwise. If they ask you to turn off the engine, do so immediately.
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.
If you are interested in a few funds, lower expense ratios make an excellent secondary factor. Would you rather invest in a fund that charges you 1% or 1.25%? Simple math says if the returns are about equal, you would want to pay lower fees. Don’t think because you aren’t investing millions of dollars that you can ignore these fees either.
Funds are required to make them known to investors, so we’re not talking about hidden fees here. There are a few ways potential investors go about determining a funds expense ratio. The primary way and likely the easiest can be done using your brokerage accounts. When looking up any fund, you’ll typically see many of its attributes along with it.
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.
Without going into all the details, the net expense ratio is eventually passed along to the investors. You can find the prospectus itself in a few ways as well. If you are already an investor, this will be sent to you every year by the fund. Search through the piles of emails in your trash bin, and you’ll likely find it in there.
Typically brokerage firms will also have the prospectus available to you when researching their site as well. Finally, you can go directly to a funds website, if available, and you’ll be able to find the prospectus there as well. It might take some poking around, but it’s there.
Mutual funds and ETFs are considered actively managed funds, meaning that they are actively making trades on your behalf within the fund regularly. An active fund typically comes with higher expense ratios as it’s more expensive to research and make trades constantly. A typical or average expense ratio for an actively traded mutual fund or Etf would be around .66%.