Mutual Funds & Expense Ratios
The stock market is considered an ideal place to find a range of companies to invest in, but it can take years of practice and experience to know what to invest in. Mutual funds offer diversification across a number of different companies and they are managed by an experienced fund manager. The amount of money the mutual fund manager needs for expenses related to fund management is called the expense ratio.
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Operational Costs
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The expense ratio is a measure of operational costs for a particular mutual fund or investment company. It is usually determined as a percentage of assets. The typical expense ratio is 1.5 percent of assets, which means fund managers get paid whether there's a profit or not. Less established fund managers may take a percentage of return. Operating expenses for a mutual fund lower the return to investors, so it is a ratio savvy investors monitor closely.
Expense Ratio
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The largest part of the expense ratio is paid out to the manger of the investment fund. Her salary is referred to as a fee. Other operational costs include bookkeeping, accounting, attorneys, auditing and other administrative fees that go along with the cost of operations. Sales fees and redemption fees are not included in the calculation of the expense ratio.
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12b-1
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Some mutual funds have a fee referred to as a 12b-1, which can be confused with the expense ratio. However, this is just the marketing cost associated with operating the fund. 12b-1 fees are actually a part of the expense ratio. All other non-operational fees are paid for directly by the investors of the fund.
Summary
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The costs of owning a mutual fund are referred to as the operational costs or the expense ratio. This is not the cost of buying the fund, which is the sales fee or load. The expense ratio covers all advisory fees for the investors, 12b-1 distribution fees, and other operational or administrative expenses.
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