What Is the Total Expense Ratio?
The total expense ratio, or TER, is a ratio that determines the percentage of costs associated with the operation and management of an investment fund relative to its assets. It is of specific importance to investors and potential investors who want to know how much it takes to run the fund and how those costs affect their earnings.
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What is the Total Expense Ratio?
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The total expense ratio is found by dividing the annual costs associated with running the fund by the fund’s net asset value. The resulting percentage shows how much of the assets are currently used to run and operate the funds annually. A higher ratio indicates a costlier fund while a smaller percentage may indicate a slightly higher return for investors. Although the total expense ratio is a good gauge of how costly an investment fund is to manage, it can vary from year to year as assets and costs increase or decrease.
Costs Included in TER
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There are many different types of costs included in calculating the total expense ratio. The main cost is the annual management charge, which is the fee the company charges to manage the details of the fund. However, there are other costs necessary to run the fund, and these expenditures may vary from investment company to investment company. Other expenses may include fund commissions, legal and registration fees and custodian fees. Regular trading costs, however, are generally not included in the TER.
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Importance to Investors
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Naturally, investors want to minimize costs and increase the returns on their portfolio. Because the total expense ratio takes several costs into consideration and not just the annual management charge, the TER is a good way to determine how those fees affect investor earnings. However, because the ratio focuses on costs, it does not necessarily determine fund performance and the success of a mutual fund in the market.
Issues with TER
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The total expense ratio may help investors determine which mutual fund may give them more bang for the buck, but there are still a few caveats when looking at the ratio. The TER is based on the costs for the preceding year, therefore an investor looking at the TER in a fund prospectus assumes that the costs will remain the same. However, this is not always the case. Also, the expense ratio does not take hidden costs into account such as brokerage fees, taxes and entrance and exit fees. Therefore, the costs are sometimes higher for the investor than what the TER portrays. By consulting with the brokerage firm and researching similar funds, investors may determine how much the mutual fund will actually cost them in the long run.
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References
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