Expense ratio

What is an expense ratio?

The expense ratio is a measure of what it costs an investment company to operate an asset fund. Investors research them to determine the rate of return on a potential investment.

Deeper definition

Mutual funds, exchange-traded funds (ETFs), and other types of investments charge fees to shareholders determined by an expense ratio. The ratio is expressed as a percentage and is calculated by dividing the fund’s operating costs by the average dollar value of assets under management. Such operating costs could include payments to management, advisers, and bookkeepers; taxes and legal expenses; and what are called 12b-1 fees, which pay for marketing and distribution. The result tells you what percentage of the fund’s assets pay for its expenses.

High expense ratios indicate a reduction in the value of the investment, while a low ratio means the asset value helps offset the fund’s expenses.

Small funds often have a high ratio, because even though the assets in the fund are limited, it must still meet management and administration fees. Larger funds might have a low expense ratio, as the costs are spread across a wider asset base. In some cases, a fund may waive a portion of its operating costs.

Bankrate’s money market comparison tool can help you make the most of your investment.

Expense ratio example

Mary is looking at different types of investments to put her money into. She finds a bond fund and puts $10,000 into it, and, after researching it, she discovers that its expense ratio is 1.4%. Over the next year, her returns averaged 5%. However, she doesn’t collect the full amount; rather, she earns 5% minus 1.4%, or 3.6%. Her actual returns are $360 instead of $500, meaning that the expense ratio consumed 28% of her returns.

 

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