Total expense ratio, also known as TER or simply "expense ratio," tells you how much it costs to operate a mutual fund or other investment fund, in relation to the assets in the fund. To calculate it, you divide the fund's operating costs by its total assets. For example, say a given fund has $800 million in assets, and the costs associated with running it are $30 million a year. The TER is $30 million divided by $800 million, or 3.75 percent.
Costs and Assets
The costs included in the TER formula typically include the fees paid to the fund manager, administrative overhead costs, and legal and auditing fees. Despite the "total" in the name, certain expenses are not included in total expense ratio. These include transaction and broker fees -- the costs incurred by the fund when it actually buys and sells assets. The total assets figure in the TER equation is simply the net value of all the assets held by the fund -- that is, all the stocks, bonds, real estate or other assets in the fund's portfolio.
Whether a particular TER is "good" or "bad" depends on the yield produced by the fund. Say two funds both produce a 7 percent gain on assets. Fund A has a TER of 4 percent, while Fund B has a TER of 5 percent. Fund A performed better for investors, since its effective return -- yield minus costs -- was 3 percent. Fund B's yield after costs was only 2 percent. Now say Fund X has a 5 percent yield and a 4 percent TER, while Fund B has an 8 percent yield and a 5 percent TER. In this case, the fund with the higher TER actually generates a better effective return for investors: 3 percent for Fund Y vs. 1 percent for Fund X.