Investing in mutual funds and exchange traded funds are great ways for smaller investors to begin investing in the stock market. They are also a great way for people without a lot of money to invest in the stock market. But they have an ugly secret, an expense ratio.
While on the surface you might overlook the dark side of an expense ratio, after all, mutual funds and ETFs are helping you to grow your wealth, if you completely ignore them, they can easily cost you thousands of dollars. And in some cases, much much more.
In this post, I am going to walk you through what an expense ratio is and how it is robbing you of your money. By the end, you will see that you need to pay more attention to this fee your favorite investment is charging you.
What Is An Expense Ratio
An expense ratio is a fee a mutual fund or exchange traded fund charges investors. The fee is also known as a management fee. Since these types of investments have a management team picking the investments and managing the daily operations of the funds, they charge this fee as their payment.
As a result, all mutual funds and exchange traded funds charge this fee. Don’t think you can find an investment that doesn’t. But what you will find is they all charge a different amount.
Typically you will see that mutual funds and ETFs that are index funds charge a much lower management fee. This is due to the lack of turnover in the fund. Since the investment is tracking an index, there is not much work for the management team to do.
As a result, they charge a lower fee. But if you have a mutual fund that has a very high turnover rate, then you can expect a high management fee.
What is considered high? Anything over 1% is high. In fact, I would argue for mutual funds that own US stocks you should not be paying anything over 0.30%. For bonds, nothing over 0.50% and for international stocks, nothing over 0.70%.
In fact, some readers of this might even think these numbers are high. The bottom line is you want the expense ratio to be as close to zero as possible.
