Expense ratio
The annual fee a mutual fund or ETF charges as a percentage of your invested amount. Compounds against you every year.
An expense ratio is the percentage of your invested assets that a fund deducts each year to cover management costs. An expense ratio of 0.50% on a $10,000 investment costs you $50 a year. Quiet, automatic, and compounding against your returns.
The difference between low and high expense ratios is enormous over time. Compare two funds, both returning 7% a year before fees:
- Fund A, 0.05% expense ratio: $10,000 grows to ~$74,300 over 30 years
- Fund B, 1.00% expense ratio: $10,000 grows to ~$57,400 over 30 years
That's a $17,000 difference from a 0.95% annual fee. The fee compounds the same way your returns do.
Modern index funds and ETFs commonly have expense ratios under 0.10%; some are as low as 0.03%. Actively managed funds often charge 0.75-1.50%. The actively-managed fund needs to beat its benchmark by its fee just to break even with the passive option — and the majority don't, year after year.
When picking a fund, the expense ratio is usually the second-most-important factor after the fund's actual holdings. Sometimes it's the most important.
See also
- Index fund — A mutual fund or ETF that holds every stock in a market index (like the S&P 500) instead of picking individual stocks. Cheap, diversified, boring — and that's the point.
- ETF (Exchange-Traded Fund) — A basket of stocks (or bonds, commodities) that trades on a stock exchange like a single stock. Most ETFs track an index.
- Diversification — Spreading your investments across many holdings so that no single one can sink your portfolio. The only free lunch in investing.
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