Complete Guide To Investment Companies, Funds And REITs


Mutual Funds - Expense Ratio

A mutual fund's expense ratio is the result of a calculation, as opposed to a type of expense. The ratio's numerator is the sum of a variety of administrative and operating expenses, while its denominator is an average of the fund's assets. It is expressed as a percentage - lower is better - and is a key indicator of a fund's investment quality.

In general operating terms, stock funds are more expensive than bond funds, international funds are more expensive than domestic funds and small- and mid-cap funds are more expensive than large-cap funds.

The largest component of a fund's operating expenses is the fee paid to its investment advisors or managers. A fund must also pay for record keeping, custodial services, taxes, legal costs, and accounting and auditing fees.

In addition to these conventional operating expenses, some funds also have a marketing, or distribution, fee commonly referred to as a 12b-1 fee. If this fee is charged, it is included in a fund's operating expenses, unlike a fund's sales charge, which is not considered an operating expense. In the mutual fund industry's early days, a provision in the regulations permitted funds to incur promotional expenses to help develop mutual fund activity. The maximum 12b-1 fee allowable is an annual 1% of a fund's assets. To be considered a no-load fund, the 12b-1 annual charge must be no more than 0.25%.

Many mutual fund observers find it hard to justify this type of fee. With the increasing popularity of mutual funds, how much more "promotion" is really necessary? Today, the 12b-1 fee is used almost exclusively to reward intermediaries for selling a fund's shares. There is a movement underway to eliminate the fee, but the fund industry as a whole is resisting the change.

Lastly, it seems that some mutual fund investors are not all that clear on how operating expenses are paid. The simple answer is that whatever is included in a fund's operating expense is charged against the assets under management. In other words, the fund's investors pay the tab. This is how costs reduce investment returns.

Related Reading:

Commission & Redemption Fees
Related Articles
  1. 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.
  2. Investing Basics

    The Lipper Rating System Explained

    Take a closer look at how Lipper Inc., a subsidiary of Thomas Reuters, determines the ratings for mutual funds in its Lipper Rating System.
  3. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  4. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  5. Taxes

    Here's How to Deduct Your Stock Losses From Your Tax Bill

    Learn the proper procedure for deducting stock investing losses, and get some tips on how to strategically take losses to lower your income tax bill.
  6. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  7. Mutual Funds & ETFs

    Top 4 Global Real Estate Mutual Funds

    Read about four of the best global real estate mutual funds, which invest in the securities of real estate companies or real estate investment trusts (REITs).
  8. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  9. Professionals

    Top 5 Highest Paid Hedge Fund Managers

    Understand what a hedge fund is and why hedge fund managers make so much money. Learn about the top 5 highest paid hedge fund managers.
  10. Investing Basics

    6 Reasons Hedge Funds Underperform

    Understand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
  1. Private Equity Real Estate

    A Definition of "Private Equity Real Estate" and how it applies ...
  2. Alpha

    Alpha is used in finance to represent two things: 1. a measure ...
  3. Capitalization Rate

    The rate of return on a real estate investment property based ...
  4. Equity

    Equity is the value of an asset less the value of all liabilities ...
  5. Derivative

    A security with a price that is dependent upon or derived from ...
  6. Real Estate Investment Trust - ...

    A REIT is a type of security that invests in real estate through ...
  1. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. What do hedge fund analysts do?

    A hedge fund analyst primarily provides support to a portfolio manager on how to best structure the hedge fund's investment ... Read Full Answer >>
  3. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  4. What are the main kinds of annuities?

    There are two broad categories of annuity: fixed and variable. These categories refer to the manner in which the investment ... Read Full Answer >>
  5. What are the risks of rolling my 401(k) into an annuity?

    Though the appeal of having guaranteed income after retirement is undeniable, there are actually a number of risks to consider ... Read Full Answer >>
  6. How do I get out of my annuity and transfer to a new one?

    If you decide your current annuity is not for you, there is nothing stopping you from transferring your investment to a new ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!