Fund fees and expense ratios: what investors pay and where to find it

Running a mutual fund or exchange-traded fund (ETF) costs money, and funds pass those costs to their investors. Most of the cost is never billed. It is deducted inside the fund. This post covers the costs of funds themselves. The separate layer of costs charged by a workplace plan is covered in the guide to what 401(k) fees cost.

Two categories of cost

The SEC's investor bulletin on fund fees and expenses divides fund costs into two groups.

• Annual fund operating expenses are ongoing costs paid out of the fund's assets every year.
• Shareholder fees are charged directly to an investor, usually in connection with a purchase, a sale or account maintenance.

Every fund has operating expenses. Shareholder fees are charged by some mutual funds and are uncommon for ETFs.

The expense ratio

A fund's total annual operating expenses, expressed as a percentage of its average net assets, is called the expense ratio. It is made up of three parts.

• Management fees are paid to the fund's investment adviser for managing the portfolio.
• Distribution and service fees, known as 12b-1 fees after the SEC rule that permits them, pay for marketing and selling fund shares, including compensation to brokers who sell them. They typically apply to mutual funds, not ETFs.
• Other expenses include custody, legal, accounting, recordkeeping and administrative costs.

The fund pays these from its own assets. That lowers the value of each share by a small amount over the course of the year. An investor never writes a check for the expense ratio. It shows up only as a slightly lower return than the fund's holdings produced.

What the percentage means in dollars

Here is a hypothetical illustration. It is simple arithmetic on a fixed balance, not a projection of any fund's results.

The percentage is charged every year on the whole balance, so the amounts add up over a long holding period, a point the SEC illustrates in its bulletin on how fees and expenses affect a portfolio. The SEC puts the principle this way: a fund with higher costs must perform better than a lower-cost fund to generate the same returns for the investor.

Cost is one characteristic of a fund among several. A lower expense ratio does not by itself make a fund the right fit, and a higher one does not by itself make it the wrong one. It is, however, a characteristic that is disclosed in advance.

Shareholder fees

Some mutual funds charge fees directly to investors.

• Front-end sales load. A percentage taken from the amount invested at purchase, typically to compensate the selling broker. In the SEC's own example, a $10,000 purchase with a 5% front-end load means $500 goes to the load and $9,500 is invested.
• Back-end or deferred sales load. Paid when shares are sold. The most common form, a contingent deferred sales charge, declines the longer the shares are held and may reach zero.
• Redemption fee. Paid to the fund itself, not to a broker, when shares are sold.
• Exchange, account and purchase fees. Charges some funds apply for moving between funds in the same family, for maintaining small accounts, or for buying shares.

A "no-load" fund charges no sales load. The SEC cautions that no-load does not mean no fees: such a fund still has operating expenses and may charge redemption, exchange or account fees.

Share classes

Many mutual funds sell several share classes. Each class owns the same underlying portfolio but carries a different combination of sales loads and ongoing expenses. One class might have a front-end load and lower annual expenses, another no front-end load and higher annual expenses.

Workplace retirement plans often have access to share classes with different pricing from those sold to individuals. The same fund can therefore cost a different amount depending on where it is held, which is one of the comparisons described in the guide to old 401(k) options.

Costs outside the fee table

Some costs do not appear in the prospectus fee table.

• Brokerage commissions. A broker may charge a commission to buy or sell ETF shares.
• ETF premiums and discounts. An ETF's market price can be above or below the value of its underlying holdings.
• The fund's own trading costs. When a fund buys and sells securities, it pays transaction costs that are not part of the expense ratio.
• Adviser fees. If a financial professional manages the account, that fee is separate from, and in addition to, the costs of the funds. See how financial advisers are paid.

Funds that own other funds

A fund that invests mainly in other funds, as target-date funds typically do, is called a fund of funds. The investor indirectly pays the expenses of the underlying funds too, and the fee table reports them on a line labeled "Acquired Fund Fees and Expenses."

Where to find the numbers

1. The prospectus fee table. Every mutual fund and ETF prospectus has a standardized table listing shareholder fees and annual operating expenses.
2. Shareholder reports. Funds send these twice a year, and they include expense information.
3. Plan fee disclosures. Workplace plans give participants information about the cost of each investment option.
4. Comparison tools. The SEC's understanding fees page links to a free fund analyzer for comparing costs across funds.

If the fee table lists a "fee waiver," the fund has agreed to reduce its expenses, temporarily or indefinitely, and the figure may rise if the waiver ends.

Questions worth asking

• What is the total annual operating expense of each fund held?
• Is there any sales load, redemption fee or account fee?
• Which share class is this, and is a lower-cost class of the same fund available?