What is the ‘Expense Ratio
The expense ratio is a measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation, where a fund’s operating expenses are divided by the average dollar value of its assets under management (AUM). Operating expenses are taken out of a fund’s assets and lower the return to a fund’s investors. It is also known as the management expense ratio (MER).
BREAKING DOWN ‘Expense Ratio
Depending on the type of fund, operating expenses vary widely. The largest component of operating expenses is the fee paid to a fund’s investment manager or advisor. Other costs include recordkeeping, custodial services, taxes, legal expenses, and accounting and auditing fees. Expenses that are charged by the fund as reflected in the fund’s daily net asset value (NAV) and do not appear as a distinct charge to shareholders.
Components of an Expense Ratio
In addition to the management fees associated with a fund, some funds have a marketing cost referred to as a 12b-1 fee. This fee, if it exists, would also be included in operating expenses. A 12b-1 fee is charged by the fund to cover its distribution and marketing costs. A fund’s 12b-1 fee can be as high as 1% annually, with 0.75% going to distribution and marketing expenses and 0.25% going to service fees.
A fund’s trading activity, the buying and selling of portfolio securities, is not included in the calculation of the expense ratio. Costs associated with mutual funds but not included in operating expenses are loads, contingent deferred sales charges (CDSC) and redemption fees, which, if they apply, are paid directly by fund investors.