What is an Expense Ratio?

Determining a mutual funds total expense ratio is a

fundamental step in choosing the right fund for your

investment dollars. Heres an understanding on

expense ratios and what they are all about.

If you invest money in mutual funds, the expense ratio is an important number to understand. Its basically

a percentage that represents the cost of owning a mutual fund. A refresher or introduction to mutual

funds: these are accounts that are invested in several different stocks and/or bonds. Several investors

pool their money together and purchase a portfolio of investments. Owning a mutual fund is beneficial

because investors are able to have ownership of several different stocks without the cost of actually

having to purchase the individual stocks. A fund manager manages the mutual fund, either on an active

or passive basis.

Components of the Expense Ratio

Here are a few of the components of the expense ratio:

Management fees are paid to the portfolio management company. These fees make up a large

part of the total expense ratio. Funds from financial institutions are often higher than those from

mutual fund companies, even for the same investments.

Transaction costs are another part of the expense ratio. If you purchased stocks outright, youd

have to pay a fee for each trade. Mutual funds have to pay these costs, too. While funds pay lower

rates per share, transaction costs are still high, especially if the fund has a high turnover.

Custody costs are charged by the custodian bank that holds the investments.

Marketing or 12b-1 fees are charged by some funds to advertise the fund.

Legal expenses for the paperwork filed with the SEC and other legal matters.

Transfer agent fees are paid to the agent who deals with the paperwork related to asset trades.

Evaluating the Total Expense Ratio

Generally, a smaller ratio is better because it means

youre getting more money from your mutual fund. You

dont pay the fee directly. Instead, the fee is built into the

funds return, which makes it tricky to know exactly how

much youve paid. Index funds have the

lowest expense ratios because these arent actively

managed. Expect to see fees around .10% to .25% on

index funds. On the other hand, actively managed funds

may have fees as high as 2% or even as low as .10%.

Funds with small assets, typically charge higher expense

ratios because they dont have as many assets to

operate from. On the other hand, funds with more assets

can spread their expenses and charge a lower expense

ratio.

Youll pay the expense ratio every year, regardless of the funds performance. And, expense ratios arent

tied to fund performance. Just because a fund has a high expense ratio doesnt mean it has a great

payout. In fact, sometimes the opposite is true. A high expense ratio cuts into your earnings and keeps

you from earning the maximum amount. Over several decades, a high expense ratio can cost millions of

dollars.

When youre evaluating a new mutual fund, you can find the total expense ratio in its prospectus. Or, you

can use an online tool like Morningstar to evaluate the features of the mutual fund. Each year, mutual fund

companies put out an annual report that shows the expense ratio charged in the previous year.

The expense ratio isnt the only type of fee you should watch out for with a mutual fund. Some have a load

or commission, typically a front-end load that you have to pay when you first purchase shares of the fund.

A fund with a 5% front-end loan would require you to pay $500 upfront when investing $10,000, for

example. Most often the load is a commission that goes to the salesperson who offers the fund. If youre

an experienced investor or are comfortable managing your own money you may want to consider a no

load mutual fund. These funds wont come with an upfront sales charge and often come with low expense