Mutual Fund Expense Ratio

Before investing in any mutual fund, the investor needs to consider both the initial cost and the final return on his investment. Often overlooked, there is another expense which involves the cost of owning and maintaining the funds. This is known as the Management Expense Ratio (MER) or the mutual fund expense ratio. This expense is never charged directly to the investor, but to the fund itself. The expense ratio is a percentage of the fund's total assets which are applied towards paying fees instead of putting the money to "work."

In order to have a comparable return on an investment, the investor will need to consider these fees: the investment advisory fee, administrative costs, 12b-1 distribution fees and other operating expenses. The investment advisory fee (or management fee) is money allotted to pay the manager or managers of the mutual fund. Such a fee generally runs from approximately 0.50% to 1.0% yearly of the fund's assets. The administrative costs involve the necessary expenses of keeping records, mailings, maintaining a customer service line and so on. The fees for marketing, advertising, and distribution services are called the 12b-1 distribution fee. It ranges from .025% to 1.0% of a fund's assets. If possible, the mutual fund investor should try to avoid funds that charge this fee.

The expense ratio includes these expenses and factors them into one number (ratio) for simplification. For an actively managed mutual fund, the average expense ratio is approximately 1.50 %, a percentage which may possibly rise. What this basically means is that each year the mutual fund keeps for itself 1.50% of the total amount in the fund. This percentage will not alter even if the fund has a bad year. If the expense ratio rises, the fund will make sure it also adjusts accordingly and match the increase.

To be a wise investor, the person wanting to invest in mutual funds will consider all the costs of owning a fund and see if the investment return will be worth the MER. To make the right decision, he can read the fund's prospectus, go to the fund's website, or visit the site Morningstar.com, which has the ratio for all the mutual funds. Here, he will discover what percentage of the total assets of the fund will be spent on fees and the money that will not be accruing as a worthwhile return on his costly investment.