A:

The answer depends on how you define "operating expenses."

Let's look at a cinematic metaphor to clear up this apparent ambiguity. A mutual fund's cost is similar to the cost of going to your local movie theater. Let's assume that the price of a movie ticket is $8. Snacks like popcorn, soft drinks and candy can easily add another $4 to the total cost of this entertainment, which means that it really costs you $12 to go to the movies.

A similar situation applies when it comes to the total costs for a mutual fund investor. There are four components to a fund's cost structure, two of which are deducted from a mutual fund's performance, which gives us its total return. Operating expenses (investment management, record keeping, custodial services, taxes, legal, accounting and auditing), expressed as the expense ratio, and a marketing/distribution fee (referred to as a 12b-1 fee, if there is one) is charged against the fund, which means that its total return is a net figure.

In addition, a fund incurs transactional costs – brokerage fees for buying and selling portfolio securities and spread differences between the bid and ask prices – which are not included in the expense ratio but certainly seem to qualify as operational expenses. These can be a significant expense item for a fund with a high portfolio turnover. Lastly, if your fund has a sales charge (load), that fee is also not included in its expense ratio.

In view of the above, a mutual fund's expense ratio is much like the price of a movie ticket in our example, while the transactional costs and sales charges are the equivalent to what a moviegoer spends at the refreshment counter. Obviously, neither the movie ticket price nor the expense ratio captures the respective total cost of a trip to the movies or a mutual fund investment.

When considering costs and expenses, a mutual fund's investment quality increases with the absence of sales charges and 12b-1 fees and the presence of low expense and portfolio turnover ratios. It is a matter of record that low-cost funds outperform high-cost funds.

The reader should note that because redemption fees for early withdrawals from a fund are controlled by the investor, not the fund company, they do not figure into this discussion.

To learn more, see Picking The Right Mutual Fund.

RELATED FAQS
  1. What kinds of expenses are included in the expense ratio?

    Understand the variety of costs and charges that are included in the total expense ratio assessed to investors using mutual ... Read Answer >>
  2. In what situations would mutual fund fees be higher than ETF fees?

    Compare the fees associated with investing in mutual funds and exchange-traded funds and find out why ETF fees are usually ... Read Answer >>
  3. When is an expense ratio considered high and when is it considered low?

    Discover what is considered an exceptionally high or low expense ratio for a mutual fund or ETF, and learn why this figure ... Read Answer >>
Related Articles
  1. Investing

    Mutual Fund Fees: Here's What You're Paying For

    It is important to understand mutual funds fees so that you know what you are paying and to whom, and how that impacts your portfolio returns.
  2. Investing

    4 Expensive Mutual Fund Mistakes to Avoid

    Mutual funds are a good way to balance your asset allocation but there some potentially expensive pitfalls investors need to be aware of.
  3. Financial Advisor

    How Mutual Fund Companies Make Money

    Read about the many different kinds of fees and sales charges mutual fund companies can use to generate revenue from those who invest in their shares.
  4. Investing

    12b-1: Understanding Mutual Fund Fees

    Many mutual funds charge investors a 12b-1 fee to pay for marketing and promotion expenses.
  5. Investing

    Looking to Buy Mutual Funds Online? Here Is How

    Learn how to buy mutual funds online; discover which websites offer mutual fund trading services, how to choose a fund and typical fees.
  6. Investing

    A Guide to Mutual Funds Trading Rules

    Make sure to review this guide on the dos and don'ts of mutual fund trading before you invest, including how trades are executed and which fees to look out for.
  7. Financial Advisor

    Pay Attention To Your Fund’s Expense Ratio

    Even small differences in an expense ratio can have a big impact on a portfolio.
  8. Financial Advisor

    How to Rate Your Mutual Fund Manager

    What to really look for when you're deciding on a mutual fund.
  9. Financial Advisor

    What is a 12b-1 Fee?

    Mutual funds typically charge between .25% and 1% in 12b-1 fees for marketing, distribution and administration expenses.
  10. Financial Advisor

    Mutual Funds: How Many is Too Many? (VTSMX, VBMFX)

    How many mutual funds are too many when it comes to a well diversified portfolio?
RELATED TERMS
  1. 12B-1 Plan

    A no-load mutual fund that is allowed to use fund assets to pay ...
  2. 12B-1 Fund

    A type of mutual fund that charges its holders 12B-1 fees instead ...
  3. 12B-1 Fee

    An annual marketing or distribution fee on a mutual fund. The ...
  4. Level Load

    An annual charge deducted from an investor's mutual fund assets ...
  5. Total Expense Ratio - TER

    A measure of the total costs associated with managing and operating ...
  6. Costs And Expenses

    As related to mutual funds, it is one of the principal criteria ...
Hot Definitions
  1. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  2. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  3. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies seeking the ...
  4. Border Adjustment Tax

    A tax levied on goods based on where they are sold – exported goods are exempt from tax; those imported and sold in the ...
  5. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
  6. Blind Trust

    A trust in which the trustees have full discretion over the assets, and the trust beneficiaries have no knowledge of the ...
Trading Center