A mutual fund's expense ratio is very important to investors because fund operating and management fees can have a large impact on net profitability. The expense ratio for a fund is calculated by dividing the total dollar value of fund assets by the total amount of fund fees – both management fees and operating expenses – charged to investors in the fund.

Expense ratios for mutual funds commonly vary between 0.1% and 2.5%. Average ratios for index funds are significantly lower than for actively managed portfolio funds, usually no more than approximately 0.25%. Expense ratios for actively managed funds most commonly fall in the range of 0.75% to 1.25%, but some funds have much higher expense ratios.

Most investors do not realize the significant impact of a seemingly small percentage difference in mutual fund expense ratios, but an example easily demonstrates that even a relatively small difference has a significant effect on net investment profits.

Consider two mutual funds, both generating an average annual investment return of 5%, with one fund charging fees of 1% and the other charging 2%. The single percentage point difference may not seem significant to most investors, but it is because the fee amount is based on assets under management, not the profit earned.

Assume two investors begin the year with respective $100,000 investments in the 1% and 2% expense ratio funds, and each fund generates a 5% return on investment before fees are deducted. The investor being charged 1% in fees loses $1,000 (1% of $100,000) of his $5,000 profit to fees. The investor paying 2% in fees pays $2,000 of his $5,000 profit. Thus, the small 1% difference in expense ratios translates to a whopping 10% difference in net profits.

(For related reading, see "Pay Attention to Your Fund's Expense Ratio.")

  1. How do mutual fund expense ratios affect returns?

    Learn what kinds of mutual fund fees there are, how to find out what fees your funds have and how they impact the future ... Read Answer >>
Related Articles
  1. Financial Advisor

    Pay Attention To Your Fund’s Expense Ratio

    Despite trends indicating an overall decrease in fees across many fund categories, investors should still pay attention to expense ratios: even small differences in fees can have a significant ...
  2. Trading

    Fund Costs and Expenses

    How much a fund charges for its services is the most important indicator of how well it will perform.
  3. Investing

    Consider These Fees When Evaluating Mutual Funds

    The best way to evaluate a mutual fund is by digging a bit deeper into the fees charged.
  4. Investing

    Trading mutual funds for beginners

    Learn the basics about mutual funds, including the types of strategies available and the different fees they may charge.
  5. Investing

    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.
  6. Investing

    Stop Paying High Mutual Fund Fees

    Discover how mutual fund fees effect your mutual fund's returns.
  7. Investing

    What You Need to Know About Mutual Funds

    Mutual funds are a good investment opportunity, but investors should know how they operate.
  8. Investing

    ETFs: Exploring Expenses in 2016 (BLK, ITOT)

    Take a good look at the latest trends in ETF costs. While passively managed funds have become less expensive, actively managed funds have not.
  9. Investing

    ETF Gross vs. Net Expense Ratios: How They Differ

    If you're going to invest in ETFs, you should know the intricacies of expense ratios.
  10. Investing

    3 Investment Fees That Are Negotiable

    Investment fees are a necessary evil but that doesn't mean they have to be overly costly. There are ways to negotiate some of the expenses down.
  1. Expense Ratio

    The expense ratio is a measure of what it costs an investment ...
  2. Service Shares

    Service shares are shares of a mutual fund that charge an extra ...
  3. Exchange Fees

    Exchange fees are a type of investment fee that some mutual funds ...
  4. No Transaction Fee Mutual Fund

    A no transaction fee mutual fund is a mutual fund with no associated ...
  5. Operating Ratio

    The operating ratio shows the efficiency of a company's management ...
  6. Performance Fee

    A performance fee is a payment made to an investment manager ...
Trading Center