Total annual fund operating expenses are a fund's costs, such as management and transaction fees and 12b-1 fees, reported as a percentage of the fund’s total assets.
Breaking Down Total Annual Fund Operating Expenses
Total annual fund operating expenses are required to be disclosed to investors in a fund’s prospectus. They are reported as a ratio known as the total expense ratio, which represents expenses as a percentage of total assets. When analyzing a fund’s annual fund operating expenses, investors will often see the following categories: management fees, distribution or 12b-1 fees, and other transaction costs.
Fund operating expenses can be classified as either gross or net. A fund’s sales loads are not included in its annual operating expenses, but they are reported in the prospectus and are an additional factor for consideration when analyzing a fund’s fees and expenses.
The three most common expense categories are:
Management fees are often the greatest portion of a fund’s operating expenses. Management fees will be higher for actively managed funds. Management fees range from 0.20% to 2.00%.
Distribution fees are a substantial part of a fund’s operating expenses. Distribution fees may also be known as 12b-1 fees. These fees are paid to third parties who partner with the fund for its distribution. Distribution fees may be paid to a third-party distributor who actively partners with the fund company to ensure distribution of a fund across multiple channels. Some funds pay trailing distribution fees to intermediaries. Intermediary distribution fees are structured with a fund’s sales commission schedule. Fund’s requiring high sales loads for intermediary brokers typically have lower 12b-1 fees and vice versa.
Gross and Net
A fund can report a gross and net expense ratio if it has contracted with entities for fee waivers and discounts. Fee waivers and discounts are typically contracted for a specific timeframe. A gross expense ratio will show the total annual expenses of a fund without any waivers or discounts. The net expense ratio will show the annual expenses with fee waivers and discounts. Waivers and discounts can potentially be extended. However, an investor can expect to pay the gross expense ratio when discounts expire.
When buying and selling publicly traded funds through full-service brokerage firms, investors will typically pay sales loads. The fund company determines the sales load schedules and outlined in the fund’s prospectus. Sales loads paid to intermediaries are not included in a fund’s total expenses.