With more than $30 trillion riding on U.S. mutual funds and exchange traded funds, you would think investors would have a strong grasp of what they pay to own the diversified portfolios.
Mutual funds and ETFs snip off money each year from the portfolio’s assets to cover their costs. Those annual costs are called the annual expense ratio. (Yes, Fidelity has four index funds that don’t charge an annual expense ratio. They are outliers.)
A recent survey by State Street Global Advisors seems to have some encouraging news. Nearly nine in 10 participants say they are aware of expense ratios. But being aware does not translate into being fee smart. Just one-third of participants said they fully understand what an expense ratio is.
And that confusion can be costly. An expense ratio is a seemingly small fee that ends up having a big impact on the growth of your fund and ETF investments over time.
Take a few minutes to master the math of expense ratios, and you just might find an easy way to boost your future performance, simply by paying less to invest in a mutual fund or ETF.
Expense ratios: The percentage you pay to own a fund
Expense ratios are expressed as a percentage. A fund with a 1% expense ratio takes 1% of the fund’s assets each year to cover its costs. A fund with an 0.50% expense ratio shaves off a half a percentage point each year to cover its costs. A fund with an 0.10% expense ratio charges one-tenth of one percent (or 10 basis points in financial lingo).
The financial service industry is quite happy if you don’t think any of that is worth your time. It loves customers who think 1% is nothing, and can’t be bothered thinking through the ramifications of paying 1% vs. 0.10%.
In reality, it is a huge deal for investors.
Let’s assume you own a fund that has a pre-fee return for the year of 8%. If that fund charges a 1% annual expense ratio, the actual gain your account is credited with will be 7%. If the fund instead charges an 0.10% expense ratio, your account will be credited with a return of 7.9%.