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jebjebitz

How do expense ratios work?

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Can anyone explain how expense ratios effect your investment?  If a fund I’m invested in has an expense ratio of 1%, is that 1% of my total assets? Or, 1% of the amount I invest in that fund that year? Or, 1% of the return from that year?etc.

Also, if I’m invested in three funds and they all have an expense ratio of 1%, how do I calculate how that is effecting my investment?

Thank you

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A mutual fund holds a number of individual stocks, whose value is determined daily by closing values of the stock market. The mutual fund's expense ratio is the annual percent it reduces that value by, daily, to calculate the fund's net asset value (NAV). The value of your fund that you see on your on-line account is the number of shares you own times that NAV. In effect, you pay it daily. 

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1 hour ago, jebjebitz said:

Also, if I’m invested in three funds and they all have an expense ratio of 1%, how do I calculate how that is effecting my investment?

Thank you

Because your balance can change over the year, let's say the average balance was $100,000. A 1% ER would result in $1000 cost per year. If instead you were invested in an index fund with an ER of 0.05%, that fund would have  cost you $50. So compared to a low-cost index fund, your fund with ER of 1% is costing you $950. That $950 goes to the mutual fund company instead of to you! Studies have shown that low costs is one of the best indicators of superior rate of returns.   

Vanguard has an excellent tool for comparing the costs of a non-Vanguard fund with that of a Vanguard fund:
https://personal.vanguard.com/us/FundsCostCompare
You can change all the inputs if you scroll down on the final page and recalculate .

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  • An expense ratio is the fee a mutual fund charges you to own the fund.
  • You don't explicitly pay this fee and the fee doesn't show up in your transaction history or anything like that. The mutual fund silently takes that money from you automatically throughout the year.
  • The expense ratio is a percentage of the amount you have invested in the fund, which is why a seemingly "small" expense ratio is a big deal. It is a mistake for investors to think of the fee in this way, instead we should think of the fee as a percentage of our post-inflation returns and luckily this calculation can be quickly approximated without pen and paper. Let's assume our portfolio returns 6% a year and inflation is 3%. That leaves a 3% real return, so if your expense ratio is 1% then the you're giving up 1/3 of your post-inflation returns.
  • If you're invested in 3 funds that have a 1% expense ratio then it is the same as if you were invested in 1 fund that has a 1% expense ratio, assuming all funds perform identically. Quick math...

TotalBalance = BalanceOne + BalanceTwo + BalanceThree

TotalBalance * 1% = FeeFromSingleFund

TotalBalance * 1% = (BalanceOne + BalanceTwo + BalanceThree) * 1% = BalanceOne*1% + BalanceTwo*1% + BalanceThree*1% = FeeFromThreeFunds

FreeFromSingleFund = FeeFromThreeFunds

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