Marketing assets

What are they and why are they important?

Select’s editorial team works independently to review financial products and write articles that we think our readers will find useful. We earn commission from affiliate partners on many offers, but not all offers on Select are from affiliate partners.

When it comes to investing, you’ve probably heard the arguments for investing your hard-earned money in exchange-traded funds (ETFs) or mutual funds to diversify your portfolio or to allocate a greater portion of your portfolio to conservative investments like bonds as you get older. . Before you begin the investment process and siphon off thousands of dollars for retirement or other future financial goals, there’s one term you definitely need to familiarize yourself with: expense ratios.

Expense ratios can erode your investment income, so it’s important to know what they are and how they work. Below, Select looks at what expense ratios are, why they matter, and how they can vary by fund type.

Subscribe to the Select newsletter!

Our top picks delivered to your inbox. Shopping recommendations that help you improve your life, delivered weekly. register here.

Definition of expense ratios

An expense ratio is essentially a commission that investors pay for managing a fund — whether it’s a index fund, mutual fund and/or ETF — which includes all administration, marketing and management fees. Try and think of it this way:

Expense ratios = the fund’s net operating expenses / the fund’s net assets

Expense ratios are usually represented as a percentage. An expense ratio of 0.2%, for example, means that for every $1,000 you invest in a fund, you’ll pay $2 a year in operating expenses. These funds are taken out of your expenses over time, so you won’t be able to avoid paying them. Just as your returns are amplified due to compound interest, so are your expenses, which is why there can be a big difference in earnings if you choose to invest in a fund with a high expense ratio.

Let’s take this example: you invest $5,000 per year and receive a constant annual rate of return of 7% on your investments. According to the table below, your income would be at least $25,000 more if you invested in the fund with an expense ratio of 0.3% compared to the fund with an expense ratio of 0.6%.

Expense ratios

Expense ratio Net costs Net profit after 30 years
0.6 $53,949.86 $451,415.35
0.5 $45,419.06 $459,946.15
0.3 $27,816.33 $477,548.88

Actively or passively managed funds

Depending on the type of fund you invest in, expense ratios can vary significantly. Actively managed mutual funds generally have a higher expense ratio than passively managed funds, primarily because passively managed funds do not have managers and researchers who actively choose assets to buy and sell.

Over the past 20 years, the expense ratios of all funds, including passive and active, have tended to decline. According to 2020 Morningstar U.S. Fund Fees Studythe asset-weighted average expense ratio fell to 0.41% in 2020 from 0.93% in 2000. Note that Morningstar uses an asset-weighted average, which weights funds based on of their size.

On the other hand, passively managed exchange-traded funds tend to have low fees since they aim to match market performance, not beat it. The average asset-weighted expense ratio for actively managed funds was 0.62% in 2020 — for passively managed funds it was just 0.12%.

When it comes to passively managed funds, index funds are a popular option among investors because they track a specific stock market index and aim to match its rate of return. For example, investors can find low-fee index funds that track the S&P 500, a popular stock market index that tracks the 500 largest U.S. companies based on market capitalization. loyalty started offering investors 0% expense ratio index funds in 2018.

Invest alone

Avant-garde

  • Minimum deposit and balance

    Deposit and minimum balance requirements may vary depending on the investment vehicle selected. No minimum to open a Vanguard account, but a minimum deposit of $1,000 to invest in many retirement funds; robo-advisor Vanguard Digital Advisor® requires a minimum of $3,000 to sign up

  • Costs

    Fees may vary depending on the investment vehicle selected. No commission fees for stock and ETF transactions; zero transaction fees for over 3,000 mutual funds; $20 annual service fee for IRAs and brokerage accounts, unless you opt for paperless statements; robo-advisor Vanguard Digital Advisor® charges up to 0.20% advisory fee (after 90 days)

  • Prime

  • Investment vehicles

    Robo-advisor: Vanguard® Digital Advisor IRA: Vanguard Traditional, Roth, Rollover, Spouse and SEP IRA Brokerage and negotiation: Avant-garde trade Other: Plan Vanguard 529

  • Investment opportunities

    Stocks, bonds, mutual funds, CDs, ETFs and options

  • Educational resources

    retirement planning tools

For investors who prefer a more passive approach, robo-advisors can be a good choice because they use an algorithm to organize your investment portfolio, periodically buying and selling investments based on your personal financial goals. Robo-advisors typically charge a management fee, which, like an expense ratio, is represented as a percentage.

For example, having an annual management fee of 0.25% means that you will have to pay the robo-advisor company $25 for managing $10,000 of investments. Keep in mind that these fees are charged on top of the expense ratio that you will have to pay for each fund in which you invest. Improvement and wealth front like the best robo-advisor services.

wealth front

On the Wealthfront secure site

  • Minimum deposit and balance

    Deposit and minimum balance requirements may vary depending on the investment vehicle selected. $500 minimum deposit for investment accounts

  • Costs

    Fees may vary depending on the investment vehicle selected. Zero account, transfer, trading or commission fees (fund ratios may apply). Wealthfront’s annual management advisory fee is 0.25% of your account balance

  • Prime

  • Investment vehicles

  • Investment opportunities

    Stocks, bonds, ETFs and cash. Additional asset classes to your portfolio include real estate, natural resources and dividend stocks

  • Educational resources

    Offers free financial planning for planning college, retirement and buying a home

At the end of the line

Although investing can be a great source of passive income, if you’re not aware of the fees you’ll have to pay in the process, you might be making less money than you think. It is useful to know the expense ratio, which includes all administrative, marketing and management expenses and is essentially the ratio of the net operating expenses of the fund to the net assets of the fund.

Actively managed funds generally have higher expense ratios because investors are paying for the potential to have a higher return. In contrast, passively managed funds like exchange-traded index funds typically have lower expense ratios because they only aim to perform as well as the broader market.

Check out Select’s in-depth coverage at personal finance, technology and tools, welfare and more, and follow us on Facebook, instagram and Twitter to stay up to date.

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.