There is a small number that can make a big difference in your investments over time. It’s called an expense ratio.
If you are unsure exactly what this fee means to your portfolio, you’re not alone. Many mutual funds and exchange-traded fund (ETF) investors would be hard-pressed to come up with a number for the expense ratio of their portfolio. But financial planners know these costs can add up, and typically work to minimize them by seeking out the thriftiest share classes.
Fortunately, that task keeps getting easier. Last year, expense ratios continued their two-decade decline, reports global financial research and investment firm Morningstar, Inc., in its latest fund fee review.
Read on to discover why that’s good news for your financial future.
Lower Fees Mean Higher Investor Returns
All mutual funds and EFTs charge shareholders a fee—based on the expense ratio—to cover annual operating costs. These include shareholder services, regulatory compliance, fund management, record-keeping, and marketing. Fund fees do not include initial or deferred sales charges, transaction fees, or brokerage charges.
The expense ratio is expressed as a percentage of a fund’s average net assets—the total value of all the portfolio’s securities less any liabilities averaged over time. The fee is taken from investor returns. The higher the ratio, the less you earn.
Morningstar’s industrywide review revealed that expense ratios were down across all funds in 2019. Investors paid the following average fees on an equal-weighted basis, meaning funds with more assets were weighted proportionately more heavily:
- 1.10% a year in actively managed U.S. equity funds, down from 1.21% in 2015.
- 0.49% in passively managed U.S. equity funds (including ETFs), down from 0.62% in 2015.
- 1.22% in actively managed international stock funds, down from 1.39%.
- 0.49% for passively managed international funds, down from 0.60%.
Overall, for all funds—including equity funds, as well as taxable and municipal bond funds, commodities, and alternative funds—the weighted average came to 1.08% a year (down from 1.20% in 2015) for actively-managed funds compared with 0.61% (down from 0.72%) for passive funds.
Operating costs can vary widely depending on investment strategy and fund size.
Morningstar credits investors’ shift toward lower-cost funds for driving the drop in expense ratios. Morningstar’s Ben Johnson cautions, however, that investors must still be vigilant about total costs. One example is the cost of advice, which has increasingly been stripped out of funds’ fees but resurfaced in the form of advice fees.
Small Shifts Can Mean Big Bucks
You may still be left wondering if such small differences in expense ratios, measured in tenths of a percent, really make a big difference in portfolio returns.
To demonstrate that the answer is a definitive “yes,” Investopedia created a chart comparing returns on several hypothetical investments that differ only in their expense ratios. The initial investment is $10,000, with an average annualized gain of 10%. The chart below shows the dramatic difference over 20 years of returns with various expense ratios:
The report points out that there is already a handful of zero-fee index mutual funds and ETFs. Further, Morningstar predicts that fund fees in active and passive categories will continue to drift lower, as consumers and advisors put their money into increasingly less expensive funds.
The experts at FJY Financial always consider the “net of fee” return of investments and are committed to implementing a strategy that supports your life goals. Feel free to reach out and create a portfolio that aligns with your plans.