Investment programs cost money to run. Mutual funds, for example, need an adviser or management group to administer the fund. They also require bookkeeping and other maintenance. These operational costs are expressed through an expense ratio.
View Expense Ratios as a Percent
The term "ratio" sometimes confuses investors when they see that expense ratios appear as a percentage. For example, if a mutual fund has an expense ratio of 1.2 percent, the expenses for that fund total 1.2 percent of its profits.
Expenses Get Paid First
Before a mutual fund's profits are distributed among shareholders, the fund must first pay its expenses. In investments with high expense ratios, investors' profits are reduced significantly. This impacts the attractiveness of the investment.
Expense Ratios Continue to Drop
Despite the negative ramifications of expense ratios, the average expenses incurred by mutual funds have declined in the last two decades, according to Investopedia. In 2012, for example, the average expense ratio for equity funds was just .77 percent, down from 1.07 percent in 1993.
Expense Ratios Matter Less Than Profitability
It stands to reason that investors want to target mutual funds and other investment vehicles with low expense ratios. However, other factors, such as transaction fees and taxes also play a part. Evaluate the scope of the mutual fund's costs and potential profits before making a decision.
Investing in mutual funds can provide investors with healthy returns. If you're new to investing (or if you're making changes to your portfolio), sign up for Mint to gain access to powerful tools and resources.