Typically, expense ratios between 0.5% and 0.75% are considered 'good' for actively managed funds. Ratios above 1.5% are considered high. In this article, we explore the meaning of the expense ratio, its formula, how it works, and its impact on returns with relevant examples.
To work out this metric, you should divide the total fund costs by the total fund assets. So if a fund has $50 million in total assets and costs $1 million to run in a given year, then its expense ratio would be 2% ($50,000,000 / $1,000,000 = 0.02)
The expense ratio is measured as a percent of your investment in the fund. For example, a fund may charge 0.30 percent. That means you'll pay $30 per year for every $10,000 you have invested in that fund. You'll pay this on an annual basis if you own the fund for the year.
A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.
Generally considered cost-efficient if the expense ratio is below 0.2%, with some options as low as 0.03%. Actively managed funds. Acceptable expense ratios are typically under 1%, though they tend to be higher due to active stock selection and management costs.
According to Morningstar, the average ETF price is 0.45%. So, at first sight, any ETF expense ratio above that value has to justify its costs with an outstanding performance.
What is the expense ratio formula? In real life, that means if the fund spends $100,000 a year on operating costs and has $10 million in assets, its expense ratio would be 0.01, or 1%. Sometimes expense ratios are expressed as basis points, or bps.
Fund B has an expense ratio of 0.75%. Again, this tells us that it is likely an actively managed fund and that we pay $75 for every $10,000 we invest. While that doesn't sound like a lot, it can add up over the course of 30 years, or once you have hundreds of thousands of dollars invested.
For a typical 401(k) plan, the expense ratio should be no higher than 2% and more likely in the 1.0% to 1.5% range. The lower the expense ratio the better, with higher fees eating into profits.
SPY is more expensive with a Total Expense Ratio (TER) of 0.0945%, versus 0.03% for VOO. SPY is up 28.31% year-to-date (YTD) with +$7.13B in YTD flows. VOO performs better with 28.36% YTD performance, and +$103.99B in YTD flows.
Low expense ratio: VOO has an expense ratio of 0.03%, one of the lowest among S&P 500 ETFs. This is cost-effective as the value of the investment grows over time.
50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).
Expense ratio: 0.02 percent. That means every $10,000 invested would cost $2 annually.
A lower expense ratio means a smaller portion of the fund's assets is used to cover operational costs, allowing more of your capital to remain invested and compound over time. This compounding can result in significantly higher returns, especially in the long term.
A good ratio is generally viewed as one between 0.5% and 0.75%, balancing cost and value. Note that, because portfolios of actively managed funds must be managed in real time, those funds usually have greater expense ratios than passively managed funds.
Generally, low-cost equity ETFs will have a net expense ratio of no more than 0.25%. Low-cost equity mutual funds will have expense ratios of 0.5% or lower. Low-cost bond ETFs often have expense ratios under 0.2%, while low-cost bond mutual funds typically have an expense ratio of 0.4% or lower.
Expense Ratios
For example, ticker symbol VOO, the Vanguard ETF that attempts to replicate the S&P 500, has an expense ratio of 0.03%, meaning that for every $1,000 you have invested in the fund, you will “pay” $3 a year in fees. You won't get a bill, it will just be deducted from the returns on the fund.
Nowadays, an expenditure ratio greater than 1.5% is usually regarded as excessive. A suitable range for an actively managed portfolio's expense ratio is 0.5% to 0.75%. The percentage for passive or index funds is typically 0.2%, however, it occasionally drops to 0.02% or less.
Expense ratios of above 1.5% are very high and can quickly eat into your returns. Most actively managed mutual funds have expense ratios ranging from 0.5% to 1.5%, whereas most passively managed funds are in the range of 0.2% to 0.5%.
The SPY comes with an 0.09% expense ratio, which is the ETF equivalent of fund management fees. An investor who invests $100,000 into the SPY ETF must pay $90 as management fees.
If an expense ratio was . 08%, that would only be $8 for every 10,000 invested.
What Is the Average ETF Expense Ratio? As of 2023, the average ETF expense ratio was 0.15% for index equity ETFs and 0.11% for index bond ETFs according to a research report from the Investment Company Institute.
For instance, if an index fund charges an expense ratio of 0.35% and you invested $15,000 for the entire year, you would pay $52.50 in fees.