The Expense Ratio of Mutual Funds

Learning how the mutual fund expense ratio affects you as an investor is a vital topic to understand. The expense ratio can tell you a lot about the mutual fund and help you decide whether to invest. Here are the basics of the expense ratio of mutual funds and how it affects you overall.

What is an Expense Ratio?

The expense ratio is a number that represents all of the costs associated with owning a mutual fund. This is a separate cost from actually acquiring a mutual fund, which is known as a load fee. Once you purchase the mutual fund, there will be other costs involved, and this is known as the expense ratio. Here are a few things that make up the expense ratio.

Management Fee

One of the biggest portions of the expense ratio is the management fee. This also might be labeled as the investment advisory fee. Regardless of what they call it on your annual report, it means the same thing. This is the money that is used to pay the fund managers for the mutual fund. For most mutual funds, you can expect this percentage to be somewhere around .5% to 1% of the total funds in a mutual fund.

Administration Costs

Another big part of the expense ratio are the administrative costs associated with running the fund. These are fees that are necessary over and above what the fund managers are paid. These costs include paying the salaries of all other employees, including customer service personnel. This also covers any mailings, accounting, and any other overhead that is associated with running the fund. These costs will range between .2% and .4%. 

12b-1 Distribution Fees

Another fee that you may be accountable for is the 12b-1 distribution fee. This is a fee that is associated with marketing for the fund. They charge you a certain percentage to help market the fee to other investors and pay for advertising. Any mass mailings that they do or commercials that they put on television are paid for with this fee. This portion of the expense ratio will usually be between .5% and 1%. As an investor, this fee can be particularly frustrating, as bringing on more investors does not help you at all. However, you are still paying for it. Many investors try to choose funds that do not include this fee.

Importance of Expense Ratio

When investing in a mutual fund, one of your biggest concerns should be the expense ratio. This is money that comes directly out of your returns and goes to the mutual fund provider. They are going to take their money regardless of whether you had a good year or a bad year. Therefore, the fund managers will still make plenty of money independent of how they perform for the year, assuming that they keep their job.

Instead of looking at the 3-year return or any other numbers when choosing a fund, the expense ratio can often tell you everything you need to know about a fund.

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