What Is a Good Expense Ratio?
An expense ratio is the percentage of your investment in a mutual fund collected by the company to pay for the fund's operations. The expense ratio goes towards paying salaries for the investment professional, trading costs and other expenses. In general, lower is better on an expense ratio, since higher ratios mean higher costs for an investor that eat into profits.
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Load vs. No-load Funds
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Mutual funds are classified as either "load" funds or "no-load" funds. In a "load" fund, an investor is charged a certain percentage of his investment immediately upon buying shares of the mutual fund. So even before the investment can gain value, the investor is making payments to the company. Most investment advisers suggest avoiding these funds and investing in "no-load" funds, instead. No-load means there is no payment or charge at the initial investment, although certain funds will charge a fee if an investment is sold within a set amount of time (90 days, 180 days and 1 year are the most common time frames).
Managed Funds
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A fund can be either actively or passively managed. In active funds, an investment professional selects a limited number of investments, usually in stocks or bonds, that she thinks will perform well and deliver large returns. The fund's holdings are likely to change more frequently to take advantage of investment values.
A passive fund, such as an index fund, seeks to simply match or mirror a large section of the investment market. These funds could focus on a certain type of investment (matching the broader bond market) or a subset of an investment type (focusing only on government bonds, or only on the stocks of energy companies, for example). Since the fund needs only to purchase the securities making up a representative sample of the chosen focus area, no active management is required.
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Index Funds
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Index funds attempt to exactly mirror the performance of a stock or bond index, such as the S&P 500 Index, an index of shares of the 500 largest publicly traded companies in the United States. An S&P 500 Index fund holds all 500 stocks in the nearly the exact ratios of their value in the index (meaning more shares of the largest companies are owned, since they hold greater weight in the index).
Because index funds have simple trading goals (mirror an existing index), they have low expense ratios. The Vanguard 500 Index Fund, for example, has one of the lowest expense ratios available to regular investors, at just 0.18 percent. While Vanguard's is one example, most other index funds have an expense ratio around 0.5 percent.
Blended Funds
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More complex funds, such as those holding both stocks and bonds, tend to have higher expense ratios because they hold a wider variety of securities and need to complete more trading activities. Actively managed funds, which may seek to make larger numbers of trades to maximize gains and hold a wider variety of investments, may offer the potential for higher returns but will generally have higher expense ratios.
Morningstar
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Though each investment company is required to prominently list the expense ratio of its funds on the fund website, it can be difficult for investors to compare the expense ratios of similar funds. One resource for accurate comparisons is provided by the investment advisory firm Morningstar, which rates funds from various companies and provides comparisons of expense ratios. A link to Morningstar's website is provided in the Resources section.
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References
Resources
- Photo Credit A businessman calculating expenses at tax time image by Christopher Meder from Fotolia.com
