Mutual Funds what is Expense Ratio

Before you give your money to one of the several charities you see on television that advertises you can help children in disadvantaged countries, you are like to ask……”How much of my money actually goes to the children?” Of course, some percentage of your contribution must be helping to pay for the televsion ad you just saw (and the aging 70’s sicom actor who is playing spokeman)right?

Think of a mutual fund the same way. Subtract the expense ratio from 100 and you will know how much of your money is going to actually buy the investment vehicle, such as stocks or bonds. If you buy a stock mutual fund with an expense ratio of 1.5%, then $98.50 dollars of every $100.00 you spend goes to purchasing the stocks. The remainder of the money goes to the many operating expenses involved in picking and researching the companies to buy, paying employees, advertising, and all of the usual expenses you associate with running a business.

At first glance, it would seem that a lower expense ratios is an indicator of a desirable fund since your dollar has a higher purchasing power. There are many other variables to consider when purchasing and evaluating mutual funds however. Clearly a 2% expense ratio won’t be nearly as troubling on a fund achieving a 15% return on your investment as a 1% expense ratio would be on a fund that returned only 10%. Generally, expense ratios run from around .5% to 3% and should only be used as one tool to evaluate a mutual fund.