Understanding Expense Ratios: What You Need to Know

June 30, 2023

As an investor, the last thing you want is to find out that a hidden fee is quietly eating away at your investment gains over time.

Unfortunately, that's exactly what can happen with expense ratios that are too high. In this blog article, we’ll address common questions related to expense ratios, including what expense ratios are and how they impact your investment returns.

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What does the term expense ratio mean?
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Expense ratios are management fees that investors pay to mutual fund companies for managing mutual funds or exchange-traded funds (ETFs). These investment vehicles provide convenience by allowing you to invest in many companies all at once. But this convenience comes at a price and that price is called an expense ratio.

The catch is expense ratios are not itemized on your account statements, which makes it challenging to know exactly what you're paying and how much you’re being charged.

Expense ratios are expressed as a percentage and can range from as low as 0.03% to as high as 1.5% or more. While this may not seem like much, even a seemingly small percentage can add up to a significant sum over time.

The fees you pay reduce the amount of money you have invested, which in turn reduces the amount of return you can earn on your investment.

The SEC provides an illustration on ongoing fees over 20 years:

Illustration of How Fees Impact Your Portfolio's Return

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An index fund or passively managed mutual fund or ETF with an expense ratio of around 0.05% is a reasonable price to pay. However, actively managed mutual funds cost more, typically around 0.75%. It’s best for investors to avoid funds with expense ratios of 1% or higher.

What's more, research on mutual funds has shown that funds with higher expense ratios often generate a lower return than funds with lower expense ratios. A study by Morningstar, found that "low-cost funds tend to lead to higher total returns and higher investor returns."

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Where can I find a mutual fund's expense ratio?

It can be difficult to determine the expense ratio of a fund. Unlike other fees that may show up on your account statements, mutual fund expense ratios are paid directly out of your investment returns. You don’t receive a bill or an invoice. This means that every year, your account balance will be reduced by the expense ratio, and you’ll miss out on potential returns if that money had stayed invested in your account.

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To learn the expense ratio of a mutual fund, simply search for your mutual fund’s ticker symbol on Google. You can typically find your ticker symbol on your portfolio's account statement. By knowing the expense ratio, you can make informed decisions about your investments and avoid expensive investments that eat away at your profits.
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What is a good expense ratio?

According to Vanguard, a Vanguard mutual fund or ETF has an average expense ratio of only 0.09%, which translates to $900 on a $1 million investment. This is much lower than the industry average’s expense ratio of 0.49%, or $4,900 on the same investment.

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Why do expense ratios matter?

Remember, expense ratios affect your bottom line, so it's important to know what you're paying.

By understanding the impact of expense ratios on your investment returns and choosing your investments wisely, you can minimize these fees from eating away at your hard-earned money.

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