ETFs Made Easy: Expense Ratios

December 01, 2014

You can and should control what you pay for a fund, but knowing the exact price can be tricky.

In this series, we answer the questions investors are afraid to ask. You can submit your questions to me at [email protected]. All correspondence will remain anonymous.

How much your investments cost is one of the only aspects investors can know in advance. You can’t predict which way the stock market will go, or where interest rates will be, or even how much money you’ll be able to invest. But costs are usually something you can plan for in advance.

They’re also one of the most important things to consider when making any investment. If you put $10,000 in a fund that costs you 1 percent a year, and the fund returns 5 percent a year, you have $20,876 at the end of 20 years. If you can find a similar fund that charges just 0.1 percent, you end up with $24,793! That’s a significant difference, and just for finding a cheaper fund.

Sometimes, however, it can be a bit tricky figuring out just how much your ETF is going to cost you.

Total Expense Ratio

The most commonly quoted cost number you’ll see on fund issuer websites or fund fact sheets or here at ETF.com is the “total expense ratio” or “expense ratio” for short. When you hear someone talk about how much an ETF—or traditional mutual fund—“costs,” expense ratio is generally the number they’re going to use.

The expense ratio isn’t what the issuer charges to run the fund, however. Instead, it’s quite simply all of the expenses that a fund has incurred over the course of a year, divided by its average assets during that year. So if a fund has $100,000 in expenses, and an average of $10 million in assets, its expense ratio is 1 percent.

But just like your household expenses, running a mutual fund isn’t necessarily that predictable. Each ETF (or mutual fund) is in fact its own little business, and it will have expenses not just to pay an advisor like BlackRock or Vanguard to run the fund (usually called the management fee, or advisory fee), but expenses for things like attorneys, pricing services, accountants and custodians, or even just maintaining its listing on the New York Stock Exchange.

Different ETF issuers deal with these expenses in different ways. Many choose to simply absorb all of these expenses for simplicity’s sake.

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