A key aspect of one’s analysis that can make the difference between various mutual funds is the expense ratio factor. The expense ratio is a yearly fee that all mutual funds and/or ETFS charge their shareholders. Simply put, it is the mutual fund’s expenses expressed as a percentage of the mutual fund’s total assets.
The Expense Ratio is a fee comprised of four major types of fees:
1. 12 B-1 fees – A yearly advertising or distribution fee for a mutual fund. It is also geared towards paying brokerage commissions. The maximum allowable percentage for a 12B-1 fee is 1% of the mutual fund’s assets.
2. Management Fees – The cost of having one’s assets managed professionally by an investment manager. Typical management fees range from 0.5 to 1% of the mutual fund’s total assets.
3. Operating Costs
4. All Other Costs Related to the Fund.
A mutual fund’s expense ratio can vary based on the category or classification of the fund itself. Many investors can end up paying a greater expense than they should if they are not aware of the average expense ratios that are charged for a particular mutual fund sector. Additionally, they must be aware of the current trends regarding the expense ratio of a mutual fund. As the charts below illustrate, mutual fund expense ratios have declined significantly over the past two decades in spite of the overall rise in mutual fund assets. This can be attributed to the fact that there are fixed fund costs that do not fluctuate with the rise or fall of mutual fund assets.
While this is beneficial for a mutual fund investor, the benefits are limited if the typical expense ratios for a particular mutual fund category are not known. Based on the previous charts shown above, mutual fund investors should not be duped into thinking that they have to pay a premium expense ratio for a fund with an above-average performance. Mutual fund investors risk gutting their overall net return if they are not aware of the average expense ratios for a specific mutual fund group. Here is a chart that shows the average mutual fund expense ratios by category: Attention should be paid to the asset-weighted average section of the chart.
Thus, the average expense ratios in the asset-weighted average section should be seen as key benchmarks in which mutual fund investors can make the right decision.
Expense ratios are just a slice of the overall pie when it comes to choosing the proper mutual fund. Stay tuned for more mutual fund articles in 2014!!