What Are "Expense Ratios?"

For the new investor considering mutual funds, one important comparison basis is their expense ratio.

The expense ratio is the operating cost of a fund, including fees (or “loads”), and it is passed on to investors.

Expense ratios are expressed in a percentage. For example, a $10,000 investment with a 0.2% expense ratio results in $20 in yearly expenses (100,000 * .002).

Funds with lower expense ratios are seen by some as delivering better investor value. For this reason, many are attracted to “no-load” index funds and no-load index exchange traded funds (ETFs), which are managed mainly by a computer.

Recently, we plunked down a chunk in our first mutual fund, the Vanguard 500, a no-load index fund that tries to mirror the performance of the S&P 500, and has an expense ratio of 0.18%

For further discussion, check out:
An Argument For Index Funds
Comparing Index ETFs and Mutual Funds

— BEN POPKEN

(Photo: Getty)

Comments

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  1. tentimesodds says:

    Why should an index fund have an expense ratio at all? You could just buy spiders or QQQ.

  2. zentec says:

    The nice thing about index funds (although I’m not excited about an S&P 500 index fund) is that they are also tax efficient. There isn’t a lot of turnover, so you’re much less likely to get a tax surprise if your fund isn’t tax deferred like a 401k/IRA.

    Some of the mutual fund jockeys command high expense ratios because they are so actively managed. Few have the performance to back it up though, and you need to look closely at how itchy the manager’s trigger finger is when the market churns. Look at expense ratios *and* turnover (along with the usual performance data) if you’re investing outside of your IRA/401k.

    An account on Morningstar can help sort it out. Morningstar’s ratings are a good place to start when researching funds. It’s not perfect, but for most people it’s one of the best objective non-biased sources of information. And a good portion of Morningstar is free, including their online mutual fund classes.

    If you decide to subscribe to Morningstar, check with your broker to see if they have a special rate on Morningstar. Fidelity has it, others might too.

  3. alpha says:

    @tentimesodds:

    Everything has an expense ratio (essentially). A quick search shows that spiders (SPY) has an expense ratio of .11%, QQQ (now known as QQQQ for whatever reason) has an expense ratio of .20%. IVV, another S&P etf has an expense ratio of .09%

  4. JustAGuy2 says:

    Um, QQQ _does_ have an expense ratio (0.2%), plus you have to pay brokerage fees to purchase or sell it. Only benefit of QQQ is the ability to trade intraday.

    http://www.amex.com/etf/EtPiPrintMain.jsp?Product_Symbol=Q

  5. captainbozo says:

    Wouldn’t 0.2% of $100,000 be $200?

  6. skittlbrau says:

    @tentimesodds:

    All mutual funds, including ETFs, have expense ratios. I work for a mutual fund company, and something has to pay salaries and overhead expenses.

    just my $.02

  7. raisincain says:

    The expense ratio is the amount the overall return is reduced by to pay for the management of the fund. It’s the fee for active management of a mutual fund. If you don’t think it’s worth the fee check out the performance of the passively managed QQQQ from March ’00 to the present, down about 60%. The Q’s are going to have to more than double before you get back to even. That’s passive management, index investing for you. If you don’t think that a professional money manager can add 1% of value to your performance you haven’t looked at the numbers. Every actively managed fund that I own, that I paid a load for and has an expense ratio higher than .18 is up over that same time period. You get what you pay for.

  8. alpha says:

    @raisincain:

    Proven fact that the vast majority of actively managed funds fail to beat the market over any significant length of time. Not to say that you haven’t happened to buy some of the good ones, but it happens.

    Furthermore, as an actively managed fund starts doing noticeably better than the overall market, investors flock to it. This causes an influx of cash to the fund that something has to be done with. In most cases, this then causes the fund manager to have to add stocks to the fund. When this happens enough, the manager suddenly doesn’t have just his “great” picks in the fund, but also some “good” and some “just ok” picks.

    Fact of life. Also, you probably could’ve found a very similar no-load fund to the load-funds you picked, with a similar or lower expense ratio. Even when buying actively-managed funds there is essentially no reason these days to ever pay a load.

  9. Notsewfast says:

    @raisincain & alpha:

    You are both right, but the foremost thing to consider when in investing is objective, if you want to be aggressive, funds with loads and good (note: good) active management might be the best way to go.

    @ alpha:

    Of course the majority of funds don’t do any better than the market. If any schmuck could put some cash into the market and beat it, then none of us in the industry would have a job. And looking at many managers’ performance in the long run assumes that you are passively managing your investments. A good portfolio manager will allocate as the market fluctuates and pick managers the he/she expects will do well. As Keynes said, in the long run, we are all dead.