- An expense ratio is defined as annual operating expenses divided by average annual net assets. However, this complex equation means little to the average investor. Most mutual funds express their expense ratio as a percentage and list it along with other pertinent fund information on their fact sheets. If a fund has an expense ratio of .5 percent, that means that an investor with a $10,000 investment will pay approximately $50 a year in fees (.5 percent of 10,000).
- The size of an expense ratio is often attributed to features of the fund, like management. Managed funds have much higher expenses than non-managed funds because they have to pay their fund managers; therefore, their expense ratios are usually a good deal higher than those of non-managed funds.
- Some mutual funds will also include advertising costs and 12b-1 fees in their expense ratio. Funds that do a great deal of advertising and marketing tend to have high expense ratios because of this. Other expenses included in the expense ratio are record-keeping, accounting and legal fees.
- Some mutual funds with high expense ratios are worth the price--if they have excellent fund managers who are capable of getting returns that beat the market as a whole. Keep in mind, however, that the fund must beat the market by at least the amount of its expense ratio to be worthwhile, which is a difficult thing to do.
- Expense ratios can range from as little as .1 percent for index funds from low-cost brokers like Vanguard to as much as 2 to 3 percent for heavily advertised, managed funds from full-service brokers. On an investment of $10,000, this can mean the difference between paying $10 a year or $300 a year in fees.
