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What’s an Expense Ratio?

By: Green Panda | Date posted: December 21, 2007 (4:13 pm) | Write a Comment (7 Comments)

After reviewing which posts were popular on my site last week, I noticed that starting an IRA was number one. I think one deterrent for people investing is the terminology associated with that. I decided to help out by putting out some quick posts demystifying financial lingo. Today’s term is expense ratio.

What are expense ratios?

What is the actual definition of an expense ratio? Here’s how Google defines it:

  • The percentage of a fund’s assets that are used to pay its annual expenses.
  • The percentage of total investment that shareholders pay annually for mutual fund management fees and operating expenses.
  • A comparison of the costs of owning and operating something to its potential gross income.

    • What does that mean for me as an investor?

    This percentage is taken back by the fund as a compensation for running the fund. It covers operations and management fees. Motley Fool points out that this money comes out of your return. Another interesting point that the Fool.com site brought up:

    Because the average large-cap value fund charges 1.17% more than the index, it has to outperform by at least that much to create value for investors — and more (maybe a lot more) if sales charges are involved. That’s a high hurdle for fund managers, many of whom trip and injure their clients’ portfolios in the process.

    What’s a good expense ratio to look for?

    In generally it appears that lower is better, but you have to factor it the performance of your fund. After all what good is a lower expense ratio if your fund does poorly?

    Where can I find out more information on mutual funds and investing?

    There are a lot of sites that have financial information. Try exploring and seeing which appeals to you personally. I recommend these:

    Photo Credit:  Aaron Edwards
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    7 Comments
    1. Comment by Dough Roller — December 21, 2007 @ 10:45 pm

      I aim to keep my weighted average expense ratio for all funds at 0.5% or lower. Right now I’m at 0.48%. You can enter your portfolio for free at Morningstar and it will give you the weighted average for all your funds. And remember that the expense ratio does not include the fund’s fees for buying and selling stocks. To get this information, you need to look at the fund’s Statement of Additional Information, which you can find on the fund’s website.

    2. Comment by Green Panda — December 21, 2007 @ 11:18 pm

      Thanks for the tip! By the way, I love your Star Trek analogy for your blog’s post today. I usually side with Spock. I’ll work on being more like Kirk. :)

    3. Comment by Amanda (Me vs Debt) — December 22, 2007 @ 11:56 am

      Wow, I was asking myself that very question this morning. Thanks for the post, great links here.

    4. Comment by Green Panda — December 22, 2007 @ 6:14 pm

      I appreciate that Amanda. Thanks for stopping by!

    5. Comment by Pinyo — December 26, 2007 @ 6:45 pm

      I did some calculation a while back and found that after 30 years, a portfolio invested at 0.5% expense ratio will be worth about 16% more than the one invested at 1% ER — assuming they both have the same return rate before ER.

    6. Comment by Green Panda — December 26, 2007 @ 7:01 pm

      Wow, I didn’t realize what a huge difference that makes! Thanks Pinyo.

    7. Pingback by I enrolled in my company's 401(k) | Green Panda Treehouse — February 19, 2008 @ 9:48 pm

      [...] those were the only two index funds I saw.  I went with the aggressive target fund because the expense fees were low and it fit my goal of aggressive growth. The other options didn’t appeal to me as many of [...]

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