An expense ratio reveals the amount that an investment company charges investors to manage an investment portfolio, a mutual fund, or an exchange-traded fund (ETF). The ratio represents all of the management fees and operating costs of the fund.
The expense ratio is calculated by dividing a mutual fund’s operating expenses by the average total dollar value of all the assets in the fund. Expense ratios are listed on the prospectus of every fund and on many financial websites.
Key Takeaways
- The expense ratio is the annual cost paid to fund managers by holders of mutual funds or ETFs.
- Competition has led expense ratios to fall dramatically over the past several years.
- A reasonable expense ratio for an actively managed portfolio is about 0.5% to 0.75%, while an expense ratio greater than 1.5% is typically considered high these days.
- For passive or index funds, the typical ratio is about 0.2% but can be as low as 0.02% or less in some cases.
High and Low Ratios
A number of factors determine whether an expense ratio is considered high or low. A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
The expense ratio for mutual funds is typically higher than expense ratios for ETFs. This is because ETFs are passively managed. The assets held in them are selected to mirror an index such as the S&P 500, and changes to the selection rarely need to be made. A mutual fund, on the other hand, is actively managed. The assets in them are constantly monitored and changed to maximize the performance of the fund.
Mutual funds tend to carry higher expense ratios than ETFs because they require more hands-on management.
The average expense ratio for actively managed mutual funds is between 0.5% and 1.0%. They rarely exceed 2.5%. For passive index funds, the typical ratio is about 0.2%.
FactorsAffecting Expense Ratios
Expenses can vary significantly between types of funds. The category of investments, the strategy for investing, and the size of the fund can all affect the expense ratio. A fund with a smaller amount of assets usually has a higher expense ratio due to its limited fund base for covering costs.
International funds can have high operational expenses because they may require staffing in several countries.
Large-cap funds, with an average expense ratio of 1.25%, are typically less expensive than small-cap funds, which average 1.4%.
The Impact on Investor Profit
Fund expenses can make a significant difference in an investor's profit. If a fund realizes an overall annual return of 5%but charges expenses that total 2%, then 40% of the fund's return is eaten by fees.
That's why investors should always compare expenses when researching funds. A fund's expenses will be listed in its prospectus and on the company's website, and can be found on many financial websites.
How Index Funds Paved the Way for Lower Expenses
As index funds have become more popular, they have encouraged lower expense ratios. Index funds replicate the return on a specific market index. This type of investing is considered passive. Their portfolio managers buy and hold a representative sample of the securities in the target indexes, and then leave them alone unless the index itself changes. Thus, index funds tend to have below-average expense ratios.
What Active Management Means
The managers of funds that are actively managed may increase or reduce the fund's exposure to individual stocks or entire sectors. They undertake considerable research and analysis when considering stocks and bonds. This additional work means that investments under active management are more costly.
Actively managed portfolios tend to be wider-ranging. Their managers look at stocks with varying market capitalizations as well as international companies and specialized sectors. Managing the assets requires more expertise.
As a general rule, mutual funds that invest in large companies should have an expense ratio of no more than 1%, while a fund that focuses on small companies or international stocks should have an expense ratio lower than 1.25%.
The Bottom Line
Like most things, you often get what you pay for. In the world of investing, however, there is ample evidence that low-cost passive funds that employ an indexing strategy often outperform active management, especially after accounting for fees and taxes. For active funds, expense ratios that are high need to be justified by extraordinary returns, or must confer some other benefit to investors since competition has made management fees decline so sharply over the past decade.
FAQs
A number of factors determine whether an expense ratio is considered high or low. A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
Is 2% a high expense ratio? ›
Typically, any expense ratio higher than 1% is high and should be avoided, however it's important to note that many investors choose to invest in funds with high expense ratios if it's worth it for them in the long run.
What is 2% expense ratio in mutual fund? ›
For example, if you invest Rs. 50,000 in a fund with an expense ratio of 2%, then you are paying the fund house Rs. 1,000 to manage your money. It can be said that if a fund earns 10% and has a 2% TER, then it means an 8% return for an investor.
Does expense ratio matter in mutual funds? ›
A mutual fund's expense ratio is very important to investors because fund operating and management fees can have a large impact on net profitability.
What is the minimum expense ratio in mutual fund? ›
Typically, the expense ratios of equity funds are higher than debt funds while active funds carry higher costs than passively-managed funds. If we look at it from the investor's perspective, a good or low expense ratio falls in the range of 0.5% and 0.75% for an actively managed mutual fund.
What is considered a bad expense ratio? ›
For mutual funds that invest in large U.S. companies, look for an expense ratio of no more than 1%. And for funds that invest in small or international companies, which typically require more research, look for an expense ratio of no more than 1.25%.
What is the Vanguard expense ratio? ›
*Vanguard average mutual fund expense ratio: 0.09%. Industry average mutual fund expense ratio: 0.54%. All averages are asset-weighted. Industry average excludes Vanguard.
Which is the best mutual fund 2023? ›
Best Performing Hybrid Mutual Funds
| Fund Name | 3-year Return (%)* | 5-year Return (%)* |
|---|
| Quant Absolute Fund Direct-Growth | 29.54% | 20.95% |
| Kotak Multi Asset Allocator FoF - Dynamic Direct-Growth | 22.09% | 17.64% |
| ICICI Prudential Equity & Debt Fund Direct-Growth | 28.66% | 16.78% |
| ICICI Prudential Multi Asset Fund Direct-Growth | 27.10% | 16.77% |
6 more rowsThere's no magic number that indicates a 401(k) expense ratio is too high or just right, and all plans are different. But if you take into account the cost of your investments in addition to the plan itself, you shouldn't be paying much more than about 1.0% to 1.50%, all in.
Is expense ratio charged every day? ›
The % can be less or more depending on whether the fund is actively or passively managed or a regular or direct plan. But it is definitely always there. Is the expense ratio charged every year? It is charged every day till you stay invested.
“The best expense ratio is the lowest expense ratio,” Arnold says. It's important to compare a fund's expense ratio with similar offerings so you don't overpay for your fund's management services. In general, an expense ratio over 1% may be too high for the average investor.
Does expense ratio change every year? ›
However, in most cases, the change in total expense ratio is quite small such as a change of around 0.01% and such small changes can occur quite frequently.
What does a higher expense ratio lead to? ›
Higher expense ratios imply a higher proportion of the returns being removed, thereby providing lower returns on investments. Since expense ratios levy a burden on annual returns earned, an investor should carefully analyse the same while choosing a mutual fund scheme to invest.
Which type of fund generally has the lowest average expense ratio? ›
Because ETFs are generally index funds and typically do not bundle distribution and account servicing or maintenance fees in their expense ratios, their expense ratios are typically low. Economies of scale and competition continued to put downward pressure on average expense ratios of ETFs in 2022.
Which small cap mutual fund has the lowest expense ratio? ›
Under Direct Plan, ITI Small Cap Fund has the lowest TER of 0.28%, followed by PGIM India Small Cap Fund (0.37%), Canara Robeco Small Cap Fund (0.4%), Kotak Small Cap Fund (0.45%), Tata Small Cap Fund (0.45%). Also Read: What is Total Expense Ratio (TER) of a mutual fund and how it affects your SIP returns?
Which index funds are best? ›
Overview of the Top Index Funds in India
- 1) UTI Nifty Next 50 Index Fund Direct-Growth. ...
- 2) Axis Nifty Next 50 Index Fund Direct-Growth. ...
- 3) Motilal Oswal S&P BSE Low Volatility Index Fund Direct-Growth. ...
- 4) Nippon India Nifty SmallCap 250 Index Fund Direct-Growth. ...
- 5) IDFC Gilt 2028 Index Fund Direct-Growth.
You do not pay for this expense ratio separately; it is calculated as a percentage of the daily investment value. For example, if you invest Rs 5000 in a mutual fund with an expense ratio of 2%, then (2%/365=0.0054%) will be deducted from the investment value each day.
What does an expense ratio of 0.2 mean? ›
An expense ratio of 0.2%, for example, means that for every $1,000 you invest in a fund, you'll be paying $2 annually in operating expenses. These funds are taken out of your expenses over time, so you won't be able to avoid paying them.
What is a healthy income to expense ratio? ›
50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).
