If you’re an investor, you need to know about expense ratios. These fees — built into all mutual funds, index funds and exchange-traded funds — can significantly drag down your portfolio returns. And while they can’t be avoided completely, you can take steps to keep these costs as low as possible.
What is an expense ratio?
An expense ratio is an annual fee that investors pay to cover a fund's expenses, such as management and marketing. If you invest in a fund with a 1% expense ratio, you’ll pay $10 annually for every $1,000 invested.
- Expense ratios are automatically deducted from your returns, but how frequently these expenses are charged varies. Some funds are deducted from your investment each day, while others are deducted at regular intervals throughout the year. Regardless of the cadence, expense ratios are simply taken out of your return, meaning you won’t receive a bill for them.
- To find a fund's expense ratio, you have to dig into the fund’s prospectus — available on the fund company’s website — or you can look on the fund’s information page on your online broker’s or retirement plan provider’s website. If you work with a financial advisor, they should also share information about these expenses with you.
» Learn more: See how much a financial advisor costs
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How expense ratios are calculated
Expense ratios are calculated by dividing annual fund expenses by total assets under management.
The formula for expense ratio is:
Expense ratio = annual fund expenses/assets under management
That means if the fund spends $100,000 a year on operating costs and has $10 million in assets, its expense ratio would be 1%.
🤓Nerdy Tip
Sometimes, expense ratios are expressed as basis points (bps). One hundred basis points is equal to 1%, so if a fund charges 40 basis points, the expense ratio will be 0.40%. If it charges 3 bps, the expense ratio will be 0.03%.What does a 0.75 expense ratio mean?
A 0.75 expense ratio means that for every hundred dollars you invest, you pay a fee of $0.75. So if you invest $10,000, you’ll pay $75.
What’s a good expense ratio?
Expense ratios can vary widely, even among the same type of fund. For example, a fund offered by one broker may have a significantly higher expense ratio than a similar fund offered by another broker. In this case, a simple switch could save you money without sacrificing returns. You can also shop the funds offered by your broker to see if you can find a similar fund for less.
Note, too, that actively managed funds and passive funds will have different expense ratios.
- Actively managed funds employ a professional manager who makes investment decisions on a day-to-day basis. These funds typically have higher expense ratios as a result.
- Passively managed funds, such as index funds, use buy-and-hold strategies that typically don't require professional management. These funds typically have lower expense ratios.
Understanding what's typical can help you determine whether you're paying too much for your investments or getting a fair deal. The average expense ratios for ETFs and mutual funds are as follows.
Equity index mutual funds: 0.05% | Equity index ETFs: 0.15%. |
Actively managed mutual funds: 0.65%. | Actively managed ETFs: 0.43%. |
Bond mutual funds: 0.37%. | Bond ETFs: 0.11%. |
Compare the expense ratios of different funds
It also helps to know the asset-weighted average expense ratio for various fund categories so you can see where you stand. This number represents the average expense ratio that investors are paying.
When you compare your fund’s fees, be sure you’re comparing apples to apples — in other words, funds of the same type and the same investment approach.
» Learn more: Understand the different types of mutual funds
Calculate the cost of investment fees
Over time, expense ratios can really eat into your returns. This calculator will show you how the difference between two expense ratios adds up over time.
Expense ratios are just one fee investors pay
Yes, you should focus on and understand these fees. But you also want to look at other costs that can weigh down your portfolio, such as administrative fees in a 401(k) or other employer-provided retirement plans, and mutual fund sales loads. If a portion of your portfolio involves stock trading, you’ll pay commissions on each trade. Those commissions generally apply to exchange-traded funds as well, because they trade on an exchange like a stock. But these days, many full-service brokers and IRA providers offer a wide range of commission-free ETFs, letting you avoid those costs on ETF trades.
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- 1.Investment Company Institute. Trends in the Expenses and Fees of Funds.
