We all hate the word “fee” because we know it’s some type of expense coming out of our pockets. While we can save a lot of money by reducing the expenses on our investments, we can’t eliminate them completely. There are costs associated with investing – you have to pay to play. That being said, we don’t want to be paying any more fees than necessary! I’m here to help demystify the world of the expense ratio—a word that you might not even associate with the word “fee”— and will arm you with some steps you can take to make sure you’re not overpaying.
What is an expense ratio?
An expense ratio is the cost associated with running a fund or ETF. This includes costs such as administration, compliance, record-keeping, management, marketing and various other costs (a particularly detestable fee in this vein is the 12b-1). Unfortunately, this cost is passed through to the investors or shareholders of the fund in the form of an expense ratio. The expense ratio is calculated annually and included in the fund’s disclosure. It’s calculated as the fund’s total expenses divided by the total assets in the fund.
Where does the fee come from?
The expense ratio comes directly from your earnings and reduces your returns. Let’s say for example, you owned a fund with an expense ratio of 2%. That might sound pretty small. If that fund earned 5% return for the year, you would have to pay 2% of those earning in fees and would retain 3% of the returns. Now that sounds a whole lot worse! If your investment is $1,000 and it earns 5%, that’s $50 in earnings. $20 of those earnings would go toward the operating expenses of the fund and you would get to keep $30. Even more, now only $30 of your $50 of earnings will be able to compound and grow for you in the future. The long-term investment implications of fees are huge!
What’s a smart investor to do?
You want to understand what’s fair. To do so, I recommend comparing fees of various funds. When comparing fees it’s important to look at comparable funds. For example, it’s typically more expensive to operate an international fund as they invest in many countries and may have to deal with expenses from compliance in different parts of the world, additional staff, etc. Large cap funds on the other hand, tend to be very inexpensive. For your retirement investments, you can use FeeX to determine the lowest fees on a certain type of fund. The site will sync with your accounts and will recommend a similar structured fund with lower fees if one exists.
Where can I find the expense ratio?
Funds are required to state their expense ratio in the fund’s prospectus which is published each year. You can also look at financial news websites like Yahoo Finance or Google Finance or use your brokerage firm’s website. Just enter the ticker and the expense ratio will most likely be listed on the summary page and if not, you can find more detailed information in the fee and expenses section. I recommended looking at the fees and expenses section regardless as you want to make sure there aren’t any hidden additional fees associated with that investment including commission, load, transaction cost or many others!
Nothing in this article should be construed as investment advice, or a solicitation or offer, or recommendation, to buy or sell any security. Investing in mutual funds, exchange traded funds, and other securities carries risk of all or part of the amount invested. Past performance is no guarantee of future results. FeeX assumes no responsibility for the tax consequences to any investor of any transaction, investors should confer with their personal advisor or tax professional regarding their particular circumstances.