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Home » Mutual Funds » Expert Tips on Mutual Funds » Pay Attention to the Expense Ratio– It Can Make or Break You!

Pay Attention to the Expense Ratio – It Can Make or Break You!

It takes money to run a mutual fund. Things such as copies, portfolio management and analyst salaries, coffee, office leases, and electricity have to be taken care of before your cash can even be invested! The percentage of assets that go toward these things – the management advisory fee and basic operating expenses – is known as the expense ratio. In short, it is the cost of owning the fund. Think of it as the amount a mutual fund has to earn just to break even before it can even begin to start growing your money.

All else being equal, you want to own funds that have the lowest possible expense ratio. If two funds have expense ratios of 0.50% and 1.5%, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, you would be shocked to see how big of a difference these seemingly paltry percentages can cause in your wealth. Just flipping open the Morningstar Funds 500 2006 Edition sitting on my desk provides an interesting illustration. Take for example, a random chosen fund, FBR Small Cap (symbol FBRVX). When all of the fees are added up, the expense projection for 10 years is $1,835. This is the amount you might be expected to pay indirectly (that is, it would be deducted from your returns before you ever saw them) if you bought $10,000 worth of the fund today. Compare that with the Vanguard 500 Index which is a passively managed fund that seeks to mimic the S&P 500 with its fees of only 0.16% per year and projected 10-year cost of $230 and it’s not hard to see why you might end up with more money in your pocket owning the latter. Combined with the low turnover ratio, which we’ll talk about later, and it’s not hard to see how a boring low-cost fund can actually make you more money than sexier offerings.



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