The expense ratio for each fund that you hold will be different, as will the amount of money that you have invested in each fund. The trick is to produce a weighted average expense ratio that will reflect the expense ratio you are paying on the total of your fund holdings.
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What Expenses Make Up the Expense Ratio?
Mutual fund expenses come from two sources – sales loads and ongoing expenses. Sales loads and other transaction costs, like broker fees, aren’t included in expense ratios. However, ongoing expenses are included.
Ongoing expenses are comprised of a number of smaller components, including:
- Portfolio management
- Fund administration
- Daily fund accounting and pricing
- Shareholder services
- 12(b) – 1 fees, which are distribution charges paid for marketing the funds
Though ongoing expenses are far less obvious to investors than sales loads, they are disclosed in the fund’s prospectus and other marketing materials. However, since they are charged internally and not paid as a specific expense, investors might easily ignore them.
See Also: The 4 Hidden Fees of Mutual Funds
Calculating the Expense Ratio of a Mutual Fund
The easiest way to determine the expense ratio of a mutual fund is simply to look at in the fund’s prospectus. However, the expense ratio presented in any printed documents will be specific to the time the document is published. The expense ratio can change over time, in part because the expenses themselves will change, but also because the value of the fund will fluctuate.
Fortunately, you can determine the current (or most recent) expense ratio calculation either on a fund family’s website or on popular investment websites such as Morningstar. Below is a quick look at what those expense ratios look like at Vanguard.
Related: The Morningstar User’s Guide
Calculating Expense Ratio Across Your Portfolio – Determining the Weighted Average
A weighted average is simply a matter of calculating the expense ratio you are incurring on two or more funds. It takes into account not only the different expense ratios that apply to each fund, but also the dollar amount of your holdings. For example, the expense ratio impact of a fund position of $10,000 is likely to be more significant than one with a fund position of $5,000. The idea is to take the various funds and produce an average expense ratio that reflects the differences in fund positions.
Let’s look at an example. We have three different funds in our portfolio, each having a different expense ratio and a different fund position.
|Fund||Amount Invested||Expense Ratio||Expense Dollar Amt.|
Armed with the above information, you can calculate the weighted expense ratio of your portfolio of funds.
To do this, divide the expense dollar amount of $345 by the total amount invested in your funds. The calculation will look like this:
$345 divided by $60,000 = 0.575%
How to Know if an Expense Ratio is High or Low
There’s no magic dividing line when it comes to expense ratios. The only guide is to compare what a specific fund charges against averages within that fund type. If you are holding one or more mutual funds, you might consider swapping out funds that have above average expense ratios for other funds with lower ratios.
The average expense ratio paid on mutual funds varies depending on the type of mutual fund. According to the Investment Company Institute (or ICI), the average expense ratio is 0.70% for equity funds, 0.57% for bond funds, and 0.78% for hybrid funds. These are just averages; higher priced funds can have expense ratios in excess of 1%, and low cost funds can be well below 0.50%.
It’s worth noting that average expense ratios have declined significantly since 2000. We can presume this has to do with greater access to information (the internet) and greater investor awareness of both the existence and importance of expense ratios.
If you want to pay rock bottom expense ratios, stay with index funds. The average ratio for the class is just 0.11%. Compare that with the 0.86% ratio average for actively managed funds.
What Difference Does a Few Tenths of a Percent Make? A Lot!
In most cases, the expense ratio per fund will be below 1%. That seems almost too trivial to worry about, but it can make a huge difference over the long-term.
Let’s say that we have two portfolios of funds, one with a weighted expense ratio of .75% and another at .25%. In each case, your average gross rate of return is 10%. But in the case of the first portfolio, your net return on investment is 9.25%, due to the reduction in that return by the expense ratio of .75%. With the second portfolio, your net return on investments is 9.75%, due to the reduction in net return by the expense ratio of .25%.
How much difference will that make in the performance of each portfolio over the next 30 years?
- First portfolio – $100,000, net rate of return on investment, 9.25%, balance after 30 years: $1,421,158.
- Second portfolio – $100,000, net rate of return on investment, 9.75%, balance after 30 years: $1,629,804.
The difference between the two portfolios after 30 years is $208,646! That’s a huge advantage achieved as a result of lowering your weighted expense ratio by “only” .50%, wouldn’t you agree?
Tools to Help Calculate Your Average Expense Ratio
There are several tools that will calculate your total expenses for you. The first, and one of our favorites, is Personal Capital. It offers a free financial dashboard that tracks not only your investments, but also your bank accounts, credit cards, and even home value.
Once you’ve connected your investment and retirement accounts, Personal Capital provides a wealth of information about your portfolio. In addition to analyzing your asset allocation, it provides details on your expenses. It even shows you how your expense ratio will affect your investment returns over time.
If you prefer using your own spreadsheet, we’ve created one just for. You can find it here. It uses Google Sheets and automatically updates with the expense ratio and values of mutual funds, ETFs, and stocks. Unlike Personal Capital, however, you do have to manually enter your investments.
Investment costs are a critical component of our success as investors. Our retirement nest egg literally depends on paying as little as possible in the way of investing expenses. While the expense ratio on each individual fund or ETF is important, it is the weighted average expense ratio of our entire portfolio that is critical to monitor.
- Calculate your weighted average expense ratio by hand, with Personal Capital, or our investment tracking spreadsheet.
- Read more on how low cost investments can improve your investment returns
- Start investing today with as little as $25 a month