What Is an Expense Ratio? The Yearly Cost of a Fund, in Plain Words

What the percentage pays for

In the fund’s prospectus fee table, the expense ratio is the line “Total Annual Fund Operating Expenses.”

It covers three kinds of costs:

• Management fees. These are paid to the fund’s investment adviser for managing the portfolio.
• Distribution and/or service fees, called 12b-1 fees. They pay for marketing and selling fund shares. They typically apply to mutual funds, not ETFs.
• Other expenses. For example legal, accounting, custodial, and transfer agent costs.

Why you never see a bill

You never receive a bill for it.

Operating expenses are paid out of the fund’s assets — the pooled money shareholders invested — so the value of the fund, and of every investor’s shares, is lower.

The SEC’s words: “Fees and expenses reduce the value of your fund’s investment returns.”

And: “A fund with higher costs must perform better than a lower-cost fund to generate the same returns for you.”

What it costs per year

This is plain arithmetic: the yearly cost is roughly your balance × the expense ratio.

On $10,000:

• 0.10% costs about $10 a year.
• 0.50% costs about $50 a year.
• 1.00% costs about $100 a year.

On $1,000:

• 0.10% costs about $1 a year.
• 0.50% costs about $5 a year.
• 1.00% costs about $10 a year.

Try it: yearly cost calculator

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Costs the expense ratio leaves out

Some costs are not inside the expense ratio.

• Shareholder fees charged to you directly. These include sales loads, redemption fees, exchange fees, and account fees. The SEC’s own example of a sales load: on a $10,000 purchase with a 5% front-end sales load, the load is $500 and $9,500 goes into shares.
• For ETFs, brokerage commissions. You may pay brokerage commissions to buy and sell.
• Some indirect costs. For example, the trading costs the fund itself pays when it buys and sells its holdings.

The SEC’s warning: “no-load does not mean no fees” — a no-load fund can still charge other fees, and a fund advertised as zero-expense can still carry costs outside the ratio.

Where to find your fund’s number

You can find a fund’s expense ratio in the fee table in the fund’s prospectus.

You can also find it in the fund’s shareholder reports, which funds must give investors twice a year.

One fund can offer several share classes holding the same investments but with different fees and expenses — so different classes of the same fund end up with different results. Check the fee table for your own class.

Comparing funds

To compare the fees of different funds, the SEC points investors to FINRA’s Fund Analyzer tool.