Expense Ratio

The percentage of assets consumed by management fees, 12b-1 fees and all other asset-based costs incurred by a mutual fund. (Brokerage costs and sales charges are not included.)

Fund expenses are worth close attention in choosing a mutual fund. High expenses can be a sign of greedy fund management as well as an indication that the fund will have a hard time outperforming the market as a whole. After all, a passively managed index fund will have few expenses, since there are no high-priced analysts to be paid. In general, an expense ratio of about 1% is about right for domestic stock funds.

Expense ratios tend to be highest in smaller mutual funds, since the cost of running the fund is spread across a smaller asset base, yet small funds are often more able to beat the market than very large funds, which can find it hard to maintain diversification without resembling the market as a whole. Expense ratios also tend to be higher on international funds, especially emerging markets funds, where (theoretically) intensive research, the far-flung nature of the investments and the rarity of expertise all drive up costs. Pay particular attention to expense ratios when investing in bond funds. Differences in expenses account for a surprising proportion of the differences in performance between many of these funds, particularly the conservative ones.

 

 

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