What Is Total Expense Ratio (TER)?

Total expense ratio, otherwise known as “TER,” comprises the total costs associated with managing and operating an investment fund. They typically applies to the major types of funds, like ETFs and mutual funds. TER can drastically influence investment decisions, as it can affect how much of a fund’s returns are actually being passed down to you. While TER is a useful measure, it’s important to evaluate it alongside the fund’s performance, as lower fees don’t always guarantee better results.

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Understanding Total Expense Ratio

TER encapsulates all of the direct costs that are deducted from a mutual fund or exchange-traded fund (ETF) to pay for its operation and management. This may include the fees that the fund manager collects, other administrative fees, as well as marketing and advertising expenses known as 12b-1 fees.

These costs, which are expressed as a percentage of a fund’s average net assets, ultimately affect the returns the investors receive. As a result, a lower TER may hint at a potentially higher return on investment, piquing the interest of some investors.

For example, imagine investing $10,000 in two identical funds – one with a TER of 0.20% and the other with a TER of 1.20%. If each investment grew 6% per year over 30 years, the money in the fund with the lower TER would be worth over $13,000 more than the other.

How TER Is Calculated

Total expense ratio comprises the various operational and management fees associated with running an investment fund.

Calculating TER is not a complex task. In fact, all it requires is a basic arithmetic calculation that looks like this:

Total Fund Costs ÷ Total Fund Assets = Total Expense Ratio

So now in practice, let’s say you’re making a decision on investing in a fund that has total costs of $20,000 and total assets of $1 million. At that point you’d divide the total cost of the fund by the total fund assets, and then multiply that by 100 to get a percentage.

That would put this fund at a TER of 2%. In other words, 2% of the fund’s total assets are deducted to cover the costs of managing and operating the fund, allowing you to compare this fund against others and make your investment decisions accordingly.

Benefits and Limitations of Using TER

Understanding TER shines a light on the costs affiliated with an investment fund, giving you a clearer picture of potential returns after expenses are deducted. Additionally, it allows investors to compare different funds more thoroughly.

A seemingly small difference in TER can accumulate into substantial savings over time. By choosing funds with lower TERs, investors can retain a greater portion of their returns, potentially fostering long-term wealth growth. Despite these practical benefits, TER shouldn’t be perceived as the best or the only tool for making investment decisions.

While TER encompasses the fund’s management fees, operational costs and other expenses, it may not capture all underlying costs, such as transaction fees and taxes. For example, a fund that frequently buys and sells assets will incur higher taxes than a passively-managed fund. The fund’s TER won’t cover those taxes. Investors should be vigilant in assessing the full scope of expenses to accurately evaluate a fund’s overall financial impact.

Also, relying solely on TER could divert attention from a fund’s performance. A low TER doesn’t guarantee superior returns. Balancing cost considerations with historical performance is essential for making informed investment decisions.

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Total Expense Ratio vs. Gross Expense Ratio

Despite sounding similar, total expense ratio and gross expense ratio (GER) are not the same. The GER of a fund refers to the total percentage of assets that cover operational and management expenses before any fee waivers and other reimbursements are applied. TER, on the other hand, is the expense ratio that’s ultimately charged to investors after those fee reductions.

Suppose you invested $10,000 in a fund with a GER of 2%. Your investment would incur $200 in fees, but the fund applies waivers and reimbursements that drop its GER by a half-percentage point. As a result, the TER is 1.5% and you end up paying $150 in fees.

Bottom Line

An investor looks over the total expense ratio of a fund in her portfolio.

Understanding the total expense ratio is an integral part of making mature investment decisions. While TER lends insight into the operational and management costs associated with an investment fund and can significantly affect fund performance and the investor’s returns, it’s not a one-size-fits-all solution for picking funds.

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