An expense ratio is what a fund charges you each year to own it, shown as a percentage of your money in the fund. An expense ratio of 0.50% means $5 a year for every $1,000 invested.
You never get a bill. The fund takes it out a little each day before it reports its return. That is why most people have no idea what theirs is.
The short answer
A good expense ratio is the lowest one available for the job you want done.
If the job is “own the whole U.S. stock market,” index funds do that for a small fraction of 1% a year. Paying much more for the same job is paying for a label.
If the job is something narrower or actively managed, the price is higher. Then the question becomes whether the extra cost has bought extra return after the fee. Often it has not.
Why small numbers matter
The SEC gives an example. Invest $100,000 and earn 4% a year for 20 years. With yearly fees of 0.25% you end with about $208,000. At 0.50%, about $198,000. At 1.00%, about $179,000.
Same investments. Same market. About $29,000 apart, only because of the fee.
The reason is that a fee does not just take this year’s dollars. It takes everything those dollars would have grown into.
A fee is paid twice. Once when it leaves, and again in the growth it never had.
How to judge your own fund
Find the number. Search the fund’s name or its ticker symbol plus “expense ratio,” or open the fund’s fact sheet. It is one line.
Compare like with like. A bond fund against other bond funds. A large-company stock fund against an index fund of large companies. Comparing a stock fund with a money market fund tells you nothing.
Ask what the extra buys. If your fund costs 0.80% and an index fund for the same part of the market costs far less, the difference is the price of the manager’s judgment. Check whether that judgment has beaten the index over ten years, after the fee.
What the expense ratio leaves out
Three things can sit on top of it.
Sales charges, called loads, when you buy or sell some funds.
An advisor’s fee, if someone manages the account for you.
Account or plan fees, such as the administration costs in a 401(k).
Your real yearly cost is all of them added together. A cheap fund inside an expensive wrapper is not cheap.
When a higher expense ratio is fine
When it is the only way to own something you actually need, and the amount is small. Or when it is the best option on a limited 401(k) menu and you would lose the employer match by going elsewhere.
Cost is not the only thing. It is the one thing you know in advance.
Related questions: mutual fund loads and 12b-1 fees, why 401(k) fees run high, what a wrap fee covers and are target date funds good.
One question for this week: which single fund holds the most of your money, and what does it charge? Start with that one.
As always, if you want to talk any of this through, the door is open. Genti