The gross expense ratio (GER) is a metric used by investors to assess the total annual cost of managing a mutual fund or exchange-traded fund (ETF). This ratio is expressed as a percentage of the fund’s average net assets, and includes management fees, administrative costs and other operational expenses.
A financial advisor can help you analyze investments and create a plan to minimizes costs and taxes.
What Is a Gross Expense Ratio?
The gross expense ratio provides a comprehensive view of the costs associated with managing a mutual fund or ETF. By breaking down the GER into its individual parts, investors can better understand where their money goes and how it affects their investment returns:
- Management fees: The primary component of a gross expense ratio is the management fee. This fee compensates the fund manager for their expertise in selecting and managing the fund’s assets.
- Administrative costs: These are the costs associated with the day-to-day operations of the fund. Administrative costs include accounting, legal, and record-keeping expenses.
- Distribution and service fees: Often referred to as 12b-1 fees, these cover the costs of marketing and selling the fund, as well as providing shareholder services.
- Custodial fees: These fees are paid to the institution that holds the fund’s assets. The custodian ensures the safekeeping and proper handling of the fund’s securities.
- Other operating expenses: This category encompasses a variety of costs such as auditing fees, regulatory filing fees, and any miscellaneous expenses required to operate the fund efficiently.
Gross Expense Ratio vs. Net Expense Ratio
While the gross expense ratio of an investment encompasses all the fees and costs associated with managing a mutual fund or ETF, the net expense ratio (NER) reflects the gross expense ratio minus any fee waivers or reimbursements from the fund’s management. This means the net expense ratio accounts for any temporary reductions in fees that the fund manager may offer to attract or retain investors. As a result, the NER typically appears lower than the GER.
While investors looking at the NER might see lower expenses, they should note that these waivers or reimbursements can be temporary. Therefore, the GER provides a more stable, long-term view of the fund’s expense structure.
How Do Expense Ratios Affect Returns?
Expense ratios directly impact the returns on an investment by reducing the amount of money that remains invested. For example, if an investment generates a 7% return, and the fund has a gross expense ratio of 1%, the net return to the investor would be 6%. This reduction can significantly affect long-term growth, as the fees compound over time, eating into potential gains.
Consider two mutual funds: Fund A and Fund B. Fund A has an annual return of 8% with an expense ratio of 0.5%, while Fund B has the same return but an expense ratio of 1.5%.
If an investor puts $10,000 into each fund, after one year, Fund A would net approximately $10,750, while Fund B would net about $10,650. Over a decade, assuming consistent returns, Fund A’s investment grows to approximately $20,610, while Fund B’s investment grows to about $18,770. This example demonstrates how even small differences in expense ratios can lead to substantial differences in returns over time.
What Is a Good Gross Expense Ratio?
A good gross expense ratio depends on the type of fund. Generally, this ratio would be one that is near or below the market average. According to the Investment Company Institute, in 2023 the average GER for ETFs was 0.15% for index-equity ETFs and 0.11% for index-bond ETFs. For mutual funds, it increased to 0.22% from 0.13% in 2022. Lower ratios indicate that the fund is more cost-efficient, which can lead to higher net returns for investors over time.
When comparing funds, it’s important to look at the gross expense ratio in the context of the fund’s performance and investment strategy. Actively managed funds usually have higher ratios due to the costs associated with research and active trading.
However, if the fund consistently outperforms its benchmark after expenses, a higher ratio might be justified. For passively managed funds, where the goal is to match market returns, a lower ratio is preferred as it minimizes costs.
Bottom Line
The gross expense ratio (GER) reflects the total annual cost of managing a mutual fund or ETF, encompassing management fees, administrative costs, distribution fees, custodial fees and other operating expenses. In contrast, the net expense ratio (NER) deducts any fee waivers or reimbursements from the GER, often presenting a lower cost. Understanding the gross expense ratio can help investors evaluate the true cost of managing their mutual funds or ETFs.
Tips for Investment Planning
- A financial advisor can help you analyze investments for your portfolio and create a plan to manage them. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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