Mutual funds are one of the best ways to invest your money. There’s a mutual fund for almost every investment style and portfolio allocation. They make it easy to diversify your investments across multiple companies’ stocks or bonds to help reduce risk.
For all their benefits, there is a drawback to using mutual funds. Each fund has an expense ratio, which is a type of fee that mutual funds charge.
We’ll go over the factors that determine a typical mutual fund’s expense ratio and how it can impact your investment.
In This Article
- What is an Expense Ratio?
- Why Do Mutual Funds Charge Fees?
- What is a Typical Expense Ratio for a Mutual Fund?
- Active vs. Passive Management
- Size of the Mutual Fund
- What the Fund Invests In
- Fund Advertising
- Why Are Expense Ratios Important?
- How Fees Affect Investment Growth Over Time
- What is a Reasonable Expense Ratio?
- Do Mutual Funds and ETFs Charge Other Fees?
- Summary
What is an Expense Ratio?
An expense ratio is a fee charged by a mutual fund. They are expressed as a percentage of your investment that you pay as a fee each year. For example, a mutual fund with an expense ratio of .5% charges you $5 each year for every $1,000 you have invested.
You don’t get a bill for these fees. Instead, the mutual fund companies bake the cost into the daily changes in the fund’s price. That means you won’t have to worry about making a monthly payment to keep your money invested. It also makes it easy to miss these fees despite their importance.
Why Do Mutual Funds Charge Fees?
Mutual funds charge fees for several reasons. At the most basic level, expense ratios and other fees help mutual funds pay for the costs involved in keeping the fund afloat.
The company managing the fund has to deal with paperwork, handle transactions, and pay fund managers. The companies pass those costs on to investors through expense ratios.
Mutual funds also want to grow their assets under management. Many fund providers advertise their funds to find more investors. And, within certain limits, they pass the costs of promoting a fund to the funds’ shareholders.
What is a Typical Expense Ratio for a Mutual Fund?
The expense ratio of a mutual fund will depend on many factors. These are some of the most important determiners of a fund’s expense ratio:
Active vs. Passive Management
Because they require more effort from fund managers, active mutual funds tend to have higher expense ratios than passive funds.
Funds with a passive management strategy usually aim to track a specific stock index. For example, an S&P 500 index fund hopes to track the movement of the S&P 500 as closely as possible.
The stocks in the S&P 500 don’t change often, so the bulk of the fund managers’ work is dealing with the funds’ investors. They don’t have to do much market research or trading.
Active funds have managers that are trying to execute a specific strategy, usually with hopes of hedging against weak markets or outpacing market gains.
These types of strategies require a lot more work and resources than passive funds do. Fund managers have to be looking for investment opportunities every day and moving money around to make sure they follow the desired plan of action.
Size of the Mutual Fund
The size of a mutual fund can have an impact on its expense ratio. In general, mutual funds with fewer assets under management have higher expense ratios. Mutual funds with more assets can charge a lower percentage.
The difference in cost caused by the size of the fund is due to economies of scale. As the number of investors and the amount invested grows, some costs will increase. For example, larger funds will need more employees capable of handling investor questions.
However, some prices are relatively fixed and change very little as more assets are invested. So as investments grow, fund managers can charge a smaller percentage of each investor’s money to cover these fixed costs.
What the Fund Invests In
Mutual fund expense ratios cover the costs of managing a fund, and costs can vary widely depending on the investments that the fund holds.
Mutual funds that focus on domestic stocks and bonds will likely carry lower expense ratios than funds that invest in foreign businesses, as the cost of foreign investment is higher.
Similarly, funds that use complicated strategies that involve derivatives or other securities that are expensive to trade will charge higher fees.
Fund Advertising
Mutual fund managers can charge 12b-1 fees as part of their funds’ expense ratios. 12b-1 costs are composed of distribution and marketing and service fees.
The distribution and marketing fee is capped at .75% annually. This portion pays brokers who sell shares in the mutual fund and covers the cost of advertising the fund to potential investors.
The service portion of the fee covers the costs of hiring employees who can help answer questions from the fund’s investors.
Why Are Expense Ratios Important?
Expense ratios are important because they can have a massive effect on your investment’s growth. It might seem obvious, every dollar you pay in fees is a dollar that you don’t have.
The thing that makes expense ratios a big deal is that expenses, like returns, compound over time. Because of this, even a small fee can have a massive impact.
How Fees Affect Investment Growth Over Time
What impact can the difference in the percentage of an expense ratio have on your investment?
Consider this example:
James has $3,000 to invest for his retirement. He puts his money in a mutual fund with an expense ratio of 1%. He adds an extra $250 to his account every month. The fund earns 10% returns each year, minus the 1% expense ratio. After 40 years, James retires and looks at his investment account. He has $1,107,875.60 that he can use during his retirement.
Jane, like James, invests $3,000 in a mutual fund, adding $250 to her investment every month. The only difference is that the mutual fund that Jane chooses has an expense ratio of .5%. If the fund returns the same 10%, minus the .5% expense ratio, after 40 years, Jane will have $1,272,718.17.
By cutting just half a percent from the expense ratio, Jane’s investment will earn almost $165,000 more than James’.
What is a Reasonable Expense Ratio?
Because expense ratios are affected by so many factors, knowing whether an expense ratio is reasonable can be difficult.
A 2018 Morningstar study found that the average expense ratio for mutual funds and ETFs was .48%. The study also noted that fees have been trending downward since 2000.
Active funds charged an average of .67% while passively managed funds charged just .15% on average.
These numbers are averages, so some funds charge higher fees and some that charge lower.
Depending on your investment strategy and goals, you may want to use a fund that charges a higher than average price. Just make sure that if you do, the fund is justifying its costs by performing as you expect.
Because of the massive effect that expense ratios have on returns, many investors are better off opting for the low-fee funds instead of chasing higher returns from expensive funds.
Do Mutual Funds and ETFs Charge Other Fees?
Every mutual fund has an expense ratio that accounts for its annual management fees. But the expense ratio isn’t the only fee funds charge. Many funds add additional fees that can impact your investment returns.
One common type of fee is a sales load. Sales loads are percentage-based commissions charged when you buy or sell shares in a fund. For example, if you buy $1,000 worth of shares in a fund with a 3% load, you’ll pay $30 in load fees.
Funds can have front-end loads (purchase commissions) or back-end loads (sales commissions). Some funds will have both.
Some funds charge purchase fees in addition to or instead of loads. While a purchase fee and front-end load seem similar, there is a difference. The broker that you use to buy or sell the fund receives loads. However, the company that operates the fund receives purchase fees.
On top of loads, some mutual funds charge redemption fees. This fee is a percentage fee charged when you sell shares shortly after you purchase them. The cost is designed to discourage investors from quickly buying and selling shares in the fund. The required holding period to avoid this fee can vary from a few days or weeks to more than a year.
Finally, some funds will charge an account fee if your balance falls below a certain amount. Most funds have a minimum investment amount. If you buy in close to the minimum and the fund loses value, you could wind up below the minimum investment amount, which is what usually triggers these fees.
Summary
Expense ratios are a percentage fee that is charged when you invest through a mutual fund. Fund managers use the fees you pay to handle the costs of running the fund. Mutual funds make it easy for you to diversify your investments, so paying the fee is often worth it.
But don’t ignore the impact that expense ratios have on your investment returns. Even a small change in the ratio can have a huge impact on your returns over a long period.
Have you invested in a mutual fund? Has the return on your investment been worth paying the fees? Let us know in the comments below.
FAQs
What is a Typical Mutual Fund Expense Ratio? ›
Mutual funds tend to carry higher expense ratios than ETFs because they require more hands-on management. The average expense ratio for actively managed mutual funds is between 0.5% and 1.0%. They rarely exceed 2.5%. For passive index funds, the typical ratio is about 0.2%.
Is a 2% expense ratio high? ›2% is considered a low fee and anything over 1% is high, according to many experts. The higher the expense ratio, the more it'll eat into your returns. Before investing, check the fees. One of the most important factors that affect the expense ratio of a fund is whether it's actively or passively managed.
How much is the average mutual fund expense ratio annually? ›It can depend on the type of fund. Equity mutual fund expense ratios average 0.47%, according to 2021 data from the Investment Company Institute. Hybrid funds average 0.57% and bond funds average 0.39%. 2 A mutual fund expense ratio that is at or below the average is ideal.
How much should I invest to get 10000 monthly? ›10,000 per month, you will need Rs. 10,0000 x 40 (years) x 12 (months in a year), which equals Rs. 48 lakh.
Which mutual fund has the lowest expense ratio? ›| Name of the Fund | Expense Ratio (%) | 1-Year Returns(%) |
|---|---|---|
| Edelweiss Long Term Equity – Direct (G) | 0.68% | 36.62% |
| Kotak Tax Saver Fund – Direct (G) | 0.72% | 37.19% |
| Mahindra Manulife ELSS – Direct (G) | 0.73% | 44.29% |
| IDFC Tax Advantage – Direct (G) | 0.74% | 49.74% |
*Vanguard average expense ratio: 0.09%. Industry average expense ratio: 0.49%. All averages are asset-weighted. Industry averages exclude Vanguard. Sources: Vanguard and Morningstar, Inc., as of December 31, 2021.
What is the average mutual fund return? ›How Mutual Funds Compare to Other Investments. Looking at the seven major categories of mutual funds above, the average annualized return for 2021 was 11.54%.
What is Charles Schwab expense ratio? ›Schwab Funds*2. The asset-weighted OER ratio for actively managed mutual funds is 0.69%. 3. OERs can range from 0.3% – 1.33%.
What is the yearly interest on 1 million dollars? ›So investing $1,000,000 in the stock market will get you $96,352 in interest in a year. This is enough to live on for most people. However, you also can lose money just as quickly. It's not unusual for you to lose 30% or even more in a market crash.
How do you make 1 cr in 5 years? ›To accumulate a corpus of Rs 1 Crore in 5 years, with an expected rate of return of 9%, you would have to start a monthly SIP of Rs 1,31,597 per month.
What's the 50 30 20 budget rule? ›
Senator Elizabeth Warren popularized the so-called "50/20/30 budget rule" (sometimes labeled "50-30-20") in her book, All Your Worth: The Ultimate Lifetime Money Plan. The basic rule is to divide up after-tax income and allocate it to spend: 50% on needs, 30% on wants, and socking away 20% to savings.
Which fund gives highest return? ›| Fund Name | 3-year Return (%)* | 5-year Return (%)* |
|---|---|---|
| Tata Digital India Fund Direct-Growth | 31.74% | 28.55% |
| ICICI Prudential Technology Direct Plan-Growth | 33.83% | 27.82% |
| Aditya Birla Sun Life Digital India Fund Direct-Growth | 32.62% | 26.64% |
| SBI Technology Opportunities Fund Direct-Growth | 29.72% | 25.75% |
When following a standard index, ETFs are more tax-efficient and more liquid than mutual funds. This can be great for investors looking to build wealth over the long haul. It is generally cheaper to buy mutual funds directly through a fund family than through a broker.
Is expense ratio charged every year? ›5000 crores). Now an expense ratio of 1.5% means that the fund house will charge 1.5% of your investment value for managing your money. However, you won't see this charge deducted annually because the daily NAV of the fund that you see is calculated after deducting the expense ratio.
Who is better Fidelity or Vanguard? ›Fidelity and Vanguard both do a good job keeping costs fairly low, but Fidelity has a slight edge overall. Both brokers charge zero commission for stock and ETF trades, but Fidelity charges $0.65 per contract on options trades, while Vanguard charges $1 per contract for customers with less than $1 million in assets.
Why are Vanguard's fees so low? ›Why are Vanguard fund fees so low? Because Vanguard is not owned by outside stockholders as most investment management companies are. Outside investors want returns, and those returns come in the form of fees charged to customers. Vanguard has no outside investors.
What is Fidelity expense ratio? ›In a mutual fund's prospectus, after the load disclosure is a section called "Annual Fund Operating Expenses." This is better known as the expense ratio. It's the percentage of assets paid to run the fund.
How do you get a 10% return on investment? ›- Invest in Stocks for the Long-Term. ...
- Invest in Stocks for the Short-Term. ...
- Real Estate. ...
- Investing in Fine Art. ...
- Starting Your Own Business (Or Investing in Small Ones) ...
- Investing in Wine. ...
- Peer-to-Peer Lending. ...
- Invest in REITs.
Industry studies estimate that professional financial advice can add between 1.5% and 4% to portfolio returns over the long term, depending on the time period and how returns are calculated. A 1-on-1 relationship with an advisor is not just about money management.
What is a good rate of return on mutual funds? ›For stock mutual funds, a “good” long-term return (annualized, for 10 years or more) is 8% to 10%. For bond mutual funds, a good long-term return would be 4% to 5%.
Is Vanguard better than Schwab? ›
In our 2020 Best Online Brokers reviews, Charles Schwab earned higher scores than Vanguard in every category we ranked, which includes Best Overall, Best for Beginners, Best Stock Trading App, Best for Day Trading, Best for International Trading, Best for Low Cost, and Best for ETFs.
Which is better Schwab or Fidelity? ›After testing 15 of the best online brokers over six months, Fidelity (95.57%) is better than Charles Schwab (89.63%). Fidelity is a value-driven online broker offering $0 trades, industry-leading research, excellent trading tools, an easy-to-use mobile app, and comprehensive retirement services.
What is a good expense ratio? ›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.
What is a good revenue to expense ratio? ›“If you are between 70% and 75%, you're probably doing okay, but if you start getting above 75%, you're trending toward being a high-cost producer.”
Can AMC change expense ratio? ›Later, when the AUM of the fund has increased sufficiently, the fund house will increase the TER to compensate for the initial low expense ratio. While investors might not like this strategy, the AMC is well within its rights to increase the TER of a scheme as long as the increase is in line with SEBI's guidelines.
What should my income to expense ratio? ›The 50/20/30 guideline offers a basic financial strategy for your spending and saving. The rule says that you should spend 50% of your income on your living expenses, like your rent and car payment. You should put 20% of your income in savings, whether that's for a rainy day fund or a down payment on a house.
What is a good sales to expense ratio? ›For a consumer catalog company, the selling expense-to-sales ratio should be between 25 percent and 30 percent of net sales. For a business-to-business cataloger, this critical ratio should range from 15 percent to 20 percent of net sales.
What's the 50 30 20 budget rule? ›Senator Elizabeth Warren popularized the so-called "50/20/30 budget rule" (sometimes labeled "50-30-20") in her book, All Your Worth: The Ultimate Lifetime Money Plan. The basic rule is to divide up after-tax income and allocate it to spend: 50% on needs, 30% on wants, and socking away 20% to savings.
Is expense ratio charged every year? ›5000 crores). Now an expense ratio of 1.5% means that the fund house will charge 1.5% of your investment value for managing your money. However, you won't see this charge deducted annually because the daily NAV of the fund that you see is calculated after deducting the expense ratio.
Is expense ratio deducted daily? ›It is deducted on a daily basis after calculating its per day expense. The annual expense ratio is divided by the number of trading days of the year and is charged on the closing gross NAV.
How much expense ratio is too much? ›
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.
Which mutual fund has highest expense ratio? ›Indian equity, hybrid MFs have one of the highest expense ratios in the world: Morningstar Study. The Morningstar Global Investor Experience (GIE) study for 2019 released on Tuesday found that India is among the most expensive countries in the world in terms of costs charged in equity and hybrid mutual funds.
Does expense ratio matter? ›Finding the expense ratio is important, because selecting a fund without looking up the expense ratio, is like buying items in a store without ever checking the price . The expense ratio of a fund does matter for your returns.
What is the 28 36 rule? ›A Critical Number For Homebuyers
One way to decide how much of your income should go toward your mortgage is to use the 28/36 rule. According to this rule, your mortgage payment shouldn't be more than 28% of your monthly pre-tax income and 36% of your total debt. This is also known as the debt-to-income (DTI) ratio.
The Income Needed To Qualify for A $500k Mortgage
A good rule of thumb is that the maximum cost of your house should be no more than 2.5 to 3 times your total annual income. This means that if you wanted to purchase a $500K home or qualify for a $500K mortgage, your minimum salary should fall between $165K and $200K.
With the 30 day savings rule, you defer all non-essential purchases and impulse buys for 30 days. Instead of spending your money on something you might not need, you're going to take 30 days to think about it. At the end of this 30 day period, if you still want to make that purchase, feel free to go for it.
How do you increase expense ratio? ›- Reducing labor costs with outsourcing.
- Implementing more efficient operations by adopting technology solutions.
A mutual fund's expense ratio is very important to investors because fund operating and management fees can have a large impact on net profitability. The expense ratio for a fund is calculated by dividing the total amount of fund fees—both management fees and operating expenses—by the total value of the fund's assets.
How does an expense ratio work? ›The expense ratio is measured as a percent of your investment in the fund. For example, a fund may charge 0.30 percent. That means you'll pay $30 per year for every $10,000 you have invested in that fund. You'll pay this on an annual basis if you own the fund for the year.