Expense Ratio

What is the expense ratio of a fund?The expense ratio tells you what percentage of assets a mutual fund, index fund, or exchange-traded fund will take from you on an annual basis as a fee for services. For example, a 1% ratio will take $1 out of a fund account that has $100. 1% might not seem like much, but over many years that 1% can take a chunk much larger than 1% out of your investment.

Here's a good example of why big costs can lower your gains by a lot. Lets say you invest $10,000 into a fund with a ratio of 0.2% and another $10,000 into a fund with a ratio of 1.2%. After 40 years, if your returns for both are 8% annually before costs, your 1st fund has $201,000 and the 2nd fund has $138,000. Saving that extra 1% in expenses made you about 50% more money - $63,000! And that's assuming the returns are the same. In fact, studies have shown that high cost funds tend to do the worse and the low cost funds tend to do the best.

What is a reasonable percentage?

Expenses are the ultimate measure of how good the returns of a mutual fund, index fund, or exchange traded fund will be. In the investing world, you do not "get what you pay for." In fact, there's a lot of evidence to suggest the opposite! The more you pay for a fund, the less you get back. I don't like the idea of lining the pockets of already rich Wall Street brokers.

For me, 1% is high. I refuse to pay for any funds that have a expenses higher than 0.4%. There are too many good funds that will cost you around 0.2% to pay anything higher than 0.4%. The only place I may break that rule is for an international fund because I expect the costs to be higher.

I've been told that I'm picky by saying don't go above 0.4%. If you're investing outside of your 401k and you have a choice where to put the money, then I see no reason to pay more than 0.4%. However, sometimes you will have no choice, but to invest in something above 0.4%, its OK to go up to 1%.

Expect significantly lower expenses for an ETF. Afterall, you have to pay a broker to buy the ETF for you while mutual and index funds generally don't charge a load fee - AKA "no load fund".

What do the expenses pay for?

You're paying for staffing and brokerage costs. The more that the fund reduces those, the smaller the expenses. If the fund requires many, high paid investment professionals to run, then your expense ratio will be higher. Why pay for an investment professional's new BMW when he or she does not provide the fund with any extra value?

Also, if the fund requires buying and selling stocks frequently - a high turnover rate - then the expense ratio will be higher.

What's the best way to keep expenses low?

Buy simple, general index funds instead of mutual funds. In fact, when you run the numbers, 80-90% of mutual funds lose to a basic all stock market index fund. The simpler the index, the cheaper it is to run and the more money that comes back to your pocket.

I recommend Vanguard's Total Stock Market Fund (VTSMX) with a low, low expense ratio of 0.18% and no load fee. A large chunk of my non-401k money is in that fund.

return from expense ratio to index funds

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