What Is an Expense Ratio?

Expense ratios can look different depending on the investment vehicle you choose. One of the most important factors that affect the expense ratio of a fund is whether it’s actively or passively managed. 

An actively managed fund has a fund manager who routinely buys and sells assets with the goal of beating the stock market. A passively managed fund, on the other hand, usually tracks the performance of a particular index or section of the stock market, but doesn’t require as much legwork from the fund company. 

What Is a Mutual Fund Expense Ratio?

A mutual fund is a type of investment that collects money from investors to purchase stocks, bonds, and other assets. A mutual fund creates a more diversified portfolio than the average investor would be able to on their own. Because mutual funds invest in a lot of different companies, they can offer a lower risk to investors. 

If a mutual fund is actively managed (which it usually is), it may entail more high-cost investment strategies, and thus have a higher expense ratio. It’s rare to see a ratio higher than 2.50%, and the industry average stands at about 0.50%. 

What Is an ETF Expense Ratio?

An exchange-traded fund (ETF) is a collection of securities such as stocks or bonds that gives an investor access to different markets. While this may sound just like a mutual fund, one big difference is that ETFs are traded on a stock exchange, and mutual funds are only traded once a day after the stock market closes.

Most ETFs are passively managed, so their expense ratios tend to be lower than most mutual funds. Since ETFs are simply tracking a benchmark index, there isn’t a need for a fund manager to conduct research and make trades. Since these costly activities are removed, the expense of operating the fund is lower. Expense ratios for ETFs tend to be lower than those for mutual funds, and the fees can start at as little as 0.05%. 

What Is an Index Fund Expense Ratio?

Index funds are passively managed funds, typically having low expense ratios. Index funds are diversified and work to track a specific section of the market or even the stock market as a whole, such as the Dow Jones Industrial Average or the S&P 500. 

Passively-managed funds don’t require an active management team, which means that the expense ratio can be maintained on the lower side. So on the expense side, these naturally come in much lower. You can find several passively managed index funds that charge expense ratios below .05%.