If you’re an investor, you need to know about expense ratios.
These fees — inherent in all mutual funds, index funds and exchange-traded funds — can significantly drag down your portfolio returns. And although they can’t be avoided, you can ensure you’re not paying too much.
What is an expense ratio? This annual fee is the percentage of your investment that goes toward the costs of running a fund. If you invest in a mutual fund with a 1% expense ratio, that will cost you $10 for every $1,000 invested. Over time, expense ratios can really eat into your returns.
How do you know what you’re paying? Expense ratios are listed in a fund’s prospectus, as well as on the fund’s information page on your online broker’s website. If you work with a financial advisor, he or she should also share information about these expenses with you.
How do you know what you should be paying? To recognize whether you’re paying too much for your investments — or getting a good deal — it helps to know the asset-weighted average expense ratio for various fund categories. This number represents the average expense ratio that investors are paying. (They’re called asset-weighted because they place more value on larger funds with more investors, in order to give a better picture of what investors actually pay.)
|Asset-weighted average mutual fund expense ratios|
|Equity mutual funds||0.70%|
|Money market funds||0.13%|
|Target date funds||0.57%|
|Index equity funds||0.11%|
Based on 2014 data from the Investment Company Institute. Asset-weighted averages place more value on larger funds with more investors, thus providing a better reflection of what investors actually pay.
Be sure you’re comparing apples to apples. Mutual funds, which are actively managed by an individual or team who makes decisions on a day-to-day basis, will have higher expense ratios. Passive funds, like index funds and exchange-traded funds, track an index rather than having a professional manager. As a result, they have lower expense ratios.
Expense ratios are just one fee investors pay
Yes, you should focus on and understand these fees. But you also want to look at other costs that can be a drag on your portfolio.
If a portion of your portfolio involves stock trading, you’ll pay commissions on each trade. Those commissions generally apply to exchange-traded funds as well, because they trade on an exchange like a stock.
But these days, many full-service brokers and IRA account providers offer a wide range of commission-free ETFs, letting you avoid those costs.
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