What a mutual fund or ETF expense ratio measures

A fund's expense ratio is the percentage of its average net assets used each year to pay the fund's operating expenses, according to the expense ratio entry on Investor.gov, the investor-education site of the Securities and Exchange Commission. The entry says those expenses can include management fees, distribution or service fees known as 12b-1 fees, acquired fund fees and expenses, and other expenses.

Investor.gov's page on mutual fund and ETF fees and expenses separates two kinds of cost. Some costs come from particular investor transactions, such as purchases, exchanges and redemptions. Others are regular, recurring, fund-wide operating expenses that are not tied to any one transaction. The page lists examples of the second kind: investment advisory fees, marketing and distribution expenses, brokerage fees, and custodial, transfer agency, legal and accountants' fees. It says funds pass these costs to shareholders as fees and expenses.

Both pages point to the same place to find the figures. The glossary says the expense ratio appears in the fee table in a fund's prospectus, and the fees page says fees and expenses are set out in a standardized fee table near the front of the prospectus. Because the table is standardized, the same line items appear in the same order from one fund's prospectus to another's.

The fees page says costs vary from fund to fund, and that a fund with high costs must perform better than a low-cost fund to generate the same returns for an investor. It adds that even small differences in fees can translate into large differences in returns over time. As a plain illustration of the arithmetic only, a ratio of 0.50% means expenses equal to half of one percent of average net assets over a year, or $5 for each $1,000 of average assets.

This explainer describes the SEC's published definitions. It does not rate, compare or recommend any fund.