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. Why is a mutual fund's expense ratio important to investors?

    Understand the nature of mutual fund expense ratios, and learn why it is critically important for investors to be aware of ... Read Answer >>
  3. Do mutual fund trading costs hurt your bottom line?

    Find out how a mutual fund's expense ratio could be eating into your bottom line, what costs are included and an example ... Read Answer >>
  4. 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 >>
  5. 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 >>
  6. Can mutual fund expense ratios be negative?

    Learn what an expense ratio is, and whether mutual funds, closed-end funds and exchange-traded funds can have negative expense ... Read Answer >>
Related Articles
  1. Mutual Funds & ETFs

    Expense Ratio

    Expense Ratio
  2. Options & Futures

    Overview Of Mutual Fund Expenses

    By Richard Loth (Contact | Biography)"In the mutual fund field, costs assume a tremendous importance for the long-term investor. Other things held equal, lower costs mean higher returns." -John ...
  3. Investing Basics

    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.
  4. Mutual Funds & ETFs

    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.
  5. Mutual Funds & ETFs

    Trading Mutual Funds For Beginners

    Learn about the basics of trading and investing in mutual funds. Understand how the fees charged by mutual funds can impact the performance of an investment.
  6. Mutual Funds & ETFs

    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.
  7. Mutual Funds & ETFs

    How To Pick A Good Mutual Fund

    Learn how to evaluate mutual funds and find the right one for you.
  8. Mutual Funds & ETFs

    A Guide For Picking Long Term Mutual Funds

    Learn about considerations for investors when buying shares in a mutual fund for a long-term investment, including fees, type of management and portfolio goals.
  9. Mutual Funds & ETFs

    Mutual Funds: The Costs

    Costs are the biggest problem with mutual funds. These costs eat into your return, and they are the main reason why the majority of funds end up with sub-par performance. What's even more disturbing ...
  10. Mutual Funds & ETFs

    5 Characteristics of Strong Mutual Fund Shares

    Discover some of the basic characteristics shared by good mutual funds that investors can use to help them in selecting funds.
RELATED TERMS
  1. Expense Ratio

    A measure of what it costs an investment company to operate a ...
  2. 12B-1 Fee

    An annual marketing or distribution fee on a mutual fund. The ...
  3. Total Annual Fund Operating Expenses

    For a mutual fund or other type of fund management structure, ...
  4. 12B-1 Plan

    A no-load mutual fund that is allowed to use fund assets to pay ...
  5. Before Reimbursement Expense Ratio

    The percentage of a fund's average net assets that is used to ...
  6. 12B-1 Fund

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

You May Also Like

Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center