What is the 'Total Expense Ratio - TER'
The total expense ratio (TER) is a measure of the total costs associated with managing and operating an investment fund, such as a mutual fund. These costs consist primarily of management fees and additional expenses, such as trading fees, legal fees, auditor fees and other operational expenses. The total cost of the fund is divided by the fund's total assets to arrive at a percentage amount, which represents the TER, most often referred to as simply "expense ratio."
BREAKING DOWN 'Total Expense Ratio - TER'
The size of the TER is important to investors, as the costs come out of the fund, affecting investors' returns. For example, if a fund generates a return of 7% for the year, but has a TER of 4%, the 7% gain is greatly diminished, to roughly 3%.
The TER provides a way for the annual costs of running a particular fund to be covered. It takes all of the known costs associated with the fund’s operation and expresses them as a single number, generally as a percentage, drawing its basis from the assets associated with the fund. This does mean that the amount provided as the TER is dependent on the success of the particular fund. The funds supplied through the TER are used to support the management, trading and legal fees associated with the fund, as well as any audit costs or general operating expenses.
Any time a fund incurs higher or lower operating expenses, those changes are likely passed along within the TER. The more actively managed the fund, the higher the associated TER. This is due to an increases in personnel costs, as well as increased transaction-based fees. By comparison, an automated fund has significantly lower costs of operation, resulting in a lower TER.
Understanding Operating Expenses
Operating expenses, or operating costs, cover any outgoing financial obligations associated with the management of the fund and the corresponding transactions. This can include employee compensation and brokerage fees, as well as any accountant fees. Other common expenses include shareholder communications and financial statements, record keeping mechanisms, and custodial services from the overseeing organization or asset manager.
A small percentage of the TER may be directed to other business operation costs. This can include things as simple as space rental and utilities for the business. Often, these expenses are referred to as overhead, and include any financial obligation that is not necessarily directed to the actual production of a good or service.