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Expense Ratio

Mutual Funds

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The total mutual fund expense ratio is the total of all annually charged expenses deducted from the portfolio once per year. This normally consists of the combination of Operating Expenses combined with 12b-1 expenses. You should judge funds based on their total expense ratio just as much as their estimated performance. You always know in advance what a fund will charge you. Meanwhile, variables such as estimated future performance can rapidly become irrelevant due to market crashes and errors. These costs directly affect your performance anyway. They are taken directly from money within the fund, reducing the compounding of interest and earnings. The higher these total fees are, the greater the drag on performance. These fees hurt your ability to compound interest long term by reducing your actual earnings. It’s equal in importance to future performance.

Expense Ratio: Losses

If your investment is suffering losses, you can add these expenses onto your loss. They will still apply. Fees do higher damage to lower return vehicles, such as bond funds, which rarely see higher returns. These expenses can easily bring a bond fund below the rate of inflation. The higher these expenses are the greater the damage they do to any fund, especially a low return fund.

Expense Ratio: Most, But Not All

Total expenses don’t actually include all annual fees encountered either. These fees do not include the trading fees created by traders who work for the fund. Brokerage fees and commissions passively absorb small amounts of assets under management. They subtract from net asset value each time there is a purchase or sale of an investment.

Expense Ratio: Comparison Shopping

You should always shop around when looking at total expense ratios. The higher the expense ratio the greater the drag on investment returns. There is a rule: only compare funds within the same category. An actively-managed small-capitalization emerging-market fund should not be compared with an index fund focused on large capitalization firms from a New York office. The small capitalization emerging market fund requires more flight, travel, research, and oversight. Accurate research will require a substantial amount of expenses. A large capitalization index fund requires significantly less expenses since it is easier to acquire data about their potential investments. They can obtain a lot of information without needing to travel. A large amount of research comes simply by buying data, news media, and analyst feeds. A comparison between them is unfair. You should always compare the fund against its most direct mutual fund competitors.

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