An expense ratio is the amount that an investment company charges investors to manage an investment portfolio, a mutual fund, or an exchange-traded fund (ETF). The ratio represents all of the management fees and operating costs of the fund.
The expense ratio is calculated by dividing a mutual fund’s operating expenses by the average total dollar value of all the assets in the fund. Expense ratios are listed on the prospectus of every fund and many financial websites.
Key Takeaways
The expense ratio is the annual cost paid to fund managers by holders of mutual funds or ETFs.
Competition has led expense ratios to fall dramatically over the past several years.
A reasonable expense ratio for an actively managed portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days.
For passive funds, the average expense ratio is about 0.12%.
High and Low Ratios
A number of factors determine whether an expense ratio is considered high or low. A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
The expense ratio for mutual funds is typically higher than the expense ratios for ETFs. This is because most ETFs are passively managed. The assets held in them are selected to mirror an index such as the S&P 500, and changes to the selections rarely need to be made. A mutual fund, on the other hand, is most often actively managed. The assets in them are constantly monitored and changed to maximize the performance of the fund.
The average expense ratio for active funds was 0.59% in 2022 (latest information from Morningstar). For passive funds, the average ratio was about 0.12%.
The largest ETF, the SPDR S&P 500 ETF Trust (SPY), has a fairly high expense ratio for an ETF at 0.0945%.
FactorsAffecting Expense Ratios
Expenses can vary significantly between types of funds. The category of investments, the strategy for investing, and the size of the fund can all affect the expense ratio. A fund with a smaller amount of assets usually has a higher expense ratio due to its limited fund base for covering costs.
International funds can have high operational expenses because they may require staffing in several countries.
Large-cap funds are typically less expensive than small-cap funds.
Fund expenses can make a significant difference in an investor's profit. If a fund realizes an overall annual return of 5%but charges expenses that total 2%, then 40% of the fund's return is eaten by fees.
That's why investors should always compare expenses when researching funds. A fund's expenses will be listed in its prospectus and on the company's website and can be found on many financial websites.
How Index Funds Paved the Way for Lower Expenses
As index funds have become more popular, they have encouraged lower expense ratios. Index funds replicate the return on a specific market index. This type of investing is considered passive. Their portfolio managers buy and hold a representative sample of the securities in the target indexes, and then leave them alone unless the index itself changes. Thus, index funds tend to have below-average expense ratios.
What Active Management Means
The managers of funds that are actively managed may increase or reduce the fund's exposure to individual stocks or entire sectors. They undertake considerable research and analysis when considering stocks and bonds. This additional work means that investments under active management are more costly.
Actively managed portfolios tend to be wider-ranging. Their managers look at stocks with varying market capitalizations as well as international companies and specialized sectors. Managing the assets requires more expertise.
As a general rule, mutual funds that invest in large companies should have an expense ratio of no more than 1%, while a fund that focuses on small companies or international stocks should have an expense ratio lower than 1.25%.
What Is an Expense Ratio?
An expense ratio is the fee that you pay to an investment fund each year. An expense ratio reduces your returns so the lower the fee, the better. Funds charge expense ratios to pay for portfolio management, administrative costs, marketing, and more.
What Is a Good Expense Ratio?
A "good" expense ratio will be determined by a variety of factors, such as if the fund is actively managed or passively managed. Generally, for an actively managed fund, good expense ratios range between 0.5% and 0.75%. Anything above 1.5% is considered high.
What Has the Lowest Expense Ratios?
Exchange-traded funds (ETFs) that are passively managed and track an index, such as the S&P 500, generally have the lowest expense ratios. This is because there is no additional research required or an increased level of buying and selling securities, simply because the funds track an index.
The Bottom Line
Like most things, you often get what you pay for. In the world of investing, however, there is ample evidence that low-cost passive funds that employ an indexing strategy often outperform active management, especially after accounting for fees and taxes. For active funds, expense ratios that are high need to be justified by extraordinary returns, or must confer some other benefit to investors since competition has resulted in declining management fees.
A reasonable expense ratio for an actively managed
actively managed
What Is Active Management? The term active management means that an investor, a professional money manager, or a team of professionals is tracking the performance of an investment portfolio and making buy, hold, and sell decisions about the assets in it.
portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days. For passive funds, the average expense ratio is about 0.12%.
The expense ratios of passively managed ETFs and mutual funds usually average around 0.05% to 0.3%, while the ratios for actively managed funds average between 0.5% and 1%.
The expense ratio is how much you pay a mutual fund or ETF per year, expressed as a percent of your investments. So, if you have $5,000 invested in an ETF with an expense ratio of . 04%, you'll pay the fund $2 annually. An expense ratio is determined by dividing a fund's operating expenses by its net assets.
The report, “Trends in the Expenses and Fees of Funds, 2023,” found that the average expense ratio for equity mutual funds fell 2 basis points to 0.42 percent, and the average expense ratio for bond mutual funds remained steady at 0.37 percent.
An expense ratio measures how much you'll pay over the course of a year to own a fund. A high expense ratio can significantly impact your returns, and it pays for things like the management of the fund, marketing, advertising and any other costs associated with running the fund.
A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
Nowadays, an expenditure ratio greater than 1.5% is usually regarded as excessive. A suitable range for an actively managed portfolio's expense ratio is 0.5% to 0.75%. The percentage for passive or index funds is typically 0.2%, however, it occasionally drops to 0.02% or less.
An expense ratio of 0.2%, for example, means that for every $1,000 you invest in a fund, you'll be paying $2 annually in operating expenses. These funds are taken out of your expenses over time, so you won't be able to avoid paying them.
For a typical 401(k) plan, the expense ratio should be no higher than 2% and more likely in the 1.0% to 1.5% range. The lower the expense ratio the better, with higher fees eating into profits.
How to find the best ETF expense ratio. High fees can turn any investment into a poor one. A good rule of thumb is to not invest in any fund with an expense ratio higher than 1% since many ETFs have expense ratios that are much lower. Also, ETFs tend to be passively managed, which keeps the management fee low.
A management fee is charged by an investment manager for managing the fund's assets, while the MER, typically called the expense ratio, represents the total cost of managing and operating a fund and is given as a percentage of the fund's total assets.
Buy and sell: *Vanguard average ETF and mutual fund expense ratio: 0.08%. Industry average ETF and mutual fund expense ratio: 0.44%. All averages are asset-weighted.
For instance, a passively managed fund with an expense ratio of 0.9% wouldn't be ideal as it is almost five times higher than the average. However, an actively managed fund with the same expense ratio of 0.9% would be considered good.
To work out this metric, you should divide the total fund costs by the total fund assets. So if a fund has $50 million in total assets and costs $1 million to run in a given year, then its expense ratio would be 2% ($50,000,000 / $1,000,000 = 0.02)
A lower expense ratio is generally preferable for investors, as it means less of the fund's assets are being used for operational expenses, potentially leading to higher net returns for investors. It's a critical metric for comparing the risks and rewards of different mutual funds.
No matter where you end up investing in a money market fund, know that you'll likely have to pay expense ratio fees (aka a management fee), which range from about 0.08% to 0.40%.
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