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. TER is also known as the 'net expense ratio' or 'after reimbursement expense ratio'.

Key Takeaways

  • Total expense ratio (TER) is a measure of mutual fund operating costs relative to assets.
  • Investors pay attention to the expense ratio to determine if a fund is an appropriate investment for them after fees are considered.
  • The total expense ratio may also be known as 'net expense ratio' or 'after reimbursement expense ratio'

The Formula for the Total Expense Ratio Is:

TER=Total fund costsTotal fund assetsTER = \frac{\text{Total fund costs}}{\text{Total fund assets}}TER=Total fund assetsTotal fund costs

How to Calculate the Total Expense Ratio

In order to calculate the total expense ratio, you must calculate the total costs and total assets of an investment fund. Total assets can be derived from financial disclosures that mutual funds report to regulators or are disseminated to analysts and investors via a prospectus. Total costs can be more difficult to accurately reflect, since TER accounts for all costs associated with operating the investment fund, including trading costs, management costs, and fees, overhead and administration costs (such as 12b-1 fees), and so on.

What Does the Total Expense Ratio Tell You?

The size of the total expense ratio (TER) is important to investors, as the costs are withdrawn from the fund, affecting investors' returns.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 increased 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 expenses 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.

The Difference Between Total Expense Ratio and Gross Expense Ratio

The gross expense ratio (GER) is the total percentage of a mutual fund's assets that are devoted to running the fund. In some cases, a fund may have agreements in place for waiving, reimbursing or recouping some of the fund’s fees. This is often the case for new funds. An investment company and its fund managers may agree to waive certain fees following the launch of a new fund to keep the expense ratio lower for investors. The total expense ratio represents the fees charged to the fund after any waivers, reimbursements, and recoupments have been made. These fee reductions are typically for a specified time-frame after which the fund may incur all full costs.

Limitations of the Total Expense Ratio

The TER is meant to capture the entire cost that an investor can expect from owning an investment fund. Some charges, however, especially those that only are only made once, or that are made from the investment capital, may not be included in the TER. These include initial charges, such as commission, stockbroker fees, securities transfer tax, and annual adviser fees.