Thursday, November 20, 2008

What the hell's an expense ratio and how much will it cost me

Blog reader Nadia in New York emailed me a question about mutual funds' "expense ratios." Sounds boring, I know, but if you own mutual funds (and you do if you're contributing to a 401(k) ), keep reading.

Nadia's question:

I am doing a direct rollover and the fund now has gone from 0 to 0.73% expense ratio. I called to inquire about how that is going to effect my pennies once everything is rolled over. I was told there would be no fees and he patted me on my head and that was that. This 0.73% means something...I work too hard for my money to be lining the pockets of fund managers.

Nadia, here's the deal: expense ratios are basically the percentage of a mutual fund's assets paid to fund managers for, well, managing the fund. Another way to look at them is as your costs of ownership. There are several types of fees that go into the ratio but unless you're interested in the minutia, all you need to worry about is the overall ratio itself. The Motley Fool has a good primer on expense ratios here.

Now, a fund having an expense ratio is not a bad thing necessarily; somebody has to pay the fund manager. That said, you don't want a fund with a ratio that's exorbitantly high compared with its peers in the same category. That'd be like buying milk for $5 a gallon when you know milk is on sale across the street at two gallons for $4.

Do some research on the kind of fund you're rolling your money into and what how its expense ratio compares with others that it competes with, and of course, pay attention to performance. And now that you know the basic definition of these fees, you should call your adviser back and ask some more informed questions.

I hope this was helpful to Nadia or anyone else out there who didn't understand what that expense ratio thing was on their mutual fund statement.

1 comment:

Butterrfly said...

Yes! That was very helpful! Thanks for that explaination. :o)