Expense Ratio
Candlefocus EditorThe expense ratio is an important measure of a mutual fund’s operating costs relative to the assets it holds. It is a way for investors to gauge the overall expenses of a mutual fund, which then allows them to make informed decisions on which fund to invest in. By taking into account fees, investors are able to compare funds and assess the costs associated with each.
Expense ratios are generally stated in three different ways: gross expense ratio, net expense ratio, and after-reimbursement expense ratio. The gross expense ratio is the total annual operating expenses, which usually includes administrative costs, management fees, distribution fees, and overhead fees. The net expense ratio deducts from the gross amount the funds that are received by the fund’s advisers or other participating companies. Lastly, the after-reimbursement expense ratio is the ratio after any funds that have been received as a reimbursement of expenses have been taken into account.
In general, expense ratios are comparatively lower for passive index funds compared to actively-managed funds. This means that passive funds require fewer assets to generate the same return as an active fund and thus have lower expenses. The same holds true for funds that demand more research which are typically funds that hold less liquid assets.
Over the past several years, the average expense ratio of mutual funds has declined. This is attributed to companies finding new ways to create cost efficiencies. Technology has been a major factor in expense ratio declines as firms are able to automate processes and lower fund management fees. Additionally, fund companies have also become more competitive as new regulations continue to suppress certain costs associated with mutual funds.
It’s important for investors to understand the expense ratios of the funds they invest in. By doing so, investors are able to make an informed decision on the fund that best suits their goals and provides the lowest cost associated with the fund. Ultimately, expense ratios provide investors with an indication of how much or how little they will have to pay in annual operating costs in order to maintain their investments.