Defining what an expense ratio means for individuals

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
SeaGhost
Posts: 2
Joined: Tue Jul 22, 2014 7:47 pm

Defining what an expense ratio means for individuals

Post by SeaGhost »

I've been searching around for a good explanation of what the expense ratio means for individual investors who buy index funds, but have not found a good answer.

For example, according to Investopedia:
A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation, where a fund's operating expenses are divided by the average dollar value of its assets under management. Operating expenses are taken out of a fund's assets and lower the return to a fund's investors.
I'm looking for how the expense ratio is charged to investors in practice. For example, if I invest $1,000 per month into a fund that has a 1% expense ratio, am I charged 1% of the principal each time I buy shares of the fund? In that case, the I would pay $120 in fees per year (1% of my $12,000 investment). Another way of asking this is - is the expense ratio fee charged only when transactions are made, or is perhaps charged only once per year (or quarterly)?

Alternatively, is a 1% expense ratio charged only against returns (performance) and not principal, or possibly principal plus returns? How does that work in practice?

I used 1% as an example for simple calculations. I'm really trying to understand how the expense ratio works in practice for companies like Vanguard that have very low expense ratios.

Thank you!
User avatar
bengal22
Posts: 2146
Joined: Sat Dec 03, 2011 5:20 pm
Location: Ohio

Re: Defining what an expense ratio means for individuals

Post by bengal22 »

1% of your holdings in the fund are siphoned away annually. Regardless of the fund's performance. The lower the expense ratio the better.
"Earn All You Can; Give All You Can; Save All You Can." .... John Wesley
Khanmots
Posts: 1241
Joined: Sat Jun 11, 2011 2:27 pm

Re: Defining what an expense ratio means for individuals

Post by Khanmots »

A 1% ER means that every year the fund owners take 1% of everything you have invested with them. They don't take it all on one day, it's spread out a little every day.

Here's an example.
Two different S&P 500 funds. Both invest in the same exact thing.

One has an ER of 0.05%
One has (had?) an ER of 2.28%

Guess which is which...

Image

Notice that the two go up and down completely in sync... they're investing in the same stuff after all. There's just a huge drag on the Rydex fund (realize that's a log scale!) That's the affect of a high expense ratio.
Investors in the Rydex fund after only 8 years or so got only 64% of the return they should have. (ending values are 17,285.03 vs 14,605.95)

Imagine how much the gap would be after 30... or 50... :shock:
Last edited by Khanmots on Tue Jul 22, 2014 9:00 pm, edited 1 time in total.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: Defining what an expense ratio means for individuals

Post by dbr »

The value of your investment is the number of shares you have in the fund multiplied by the net asset value (NAV) of a share. The NAV is computed daily by adding up the value of all the holdings of investments and cash of the fund divided by how many shares are outstanding. The company will sell holdings and/or remove cash to cover their net expenses. That means that the NAV if the fund is reduced on a daily basis to cover expenses. That means to you that the value of your investment is reduced every day to cover expenses.
Topic Author
SeaGhost
Posts: 2
Joined: Tue Jul 22, 2014 7:47 pm

Re: Defining what an expense ratio means for individuals

Post by SeaGhost »

Khanmots wrote:A 1% ER means that every year the fund owners take 1% of everything you have invested with them. They don't take it all on one day, it's spread out a little every day.

Here's an example.
Two different S&P 500 funds. Both invest in the same exact thing.

One has an ER of 0.05%
One has (had?) an ER of 2.28%

Guess which is which...

Image

Notice that the two go up and down completely in sync... they're investing in the same stuff after all. There's just a huge drag on the Rydex fund (realize that's a log scale!) That's the affect of a high expense ratio.
Investors in the Rydex fund after only 8 years or so got only 64% of the return they should have. (ending values are 17,285.03 vs 14,605.95)

Imagine how much the gap would be after 30... or 50... :shock:
Thank you for your reply. Sounds like your first sentence is in agreement with dbr. It still sounds a bit complicated. Do companies like Vanguard make it clear how much money you actually paid in fees in a year through the ER? It sounds like in my simplified example, the person could have paid a wide range of fees related to the expense ratio, depending on if their $10,000 of annual contributions became $5,000 or $15,000.

Would it be considered a rip off if they just took 1% of the principal every time you bought funds and does any company use this kind of model? Again, in my original example that would work out to $120 in fees per year on a $12,000 investment. I suppose the actual ER in this case would be less than 1% as long as the investor realized a gain. Does any company use this kind of model? I guess it's like a transaction fee in a percentage rather than fixed form. Seems simpler.
Khanmots
Posts: 1241
Joined: Sat Jun 11, 2011 2:27 pm

Re: Defining what an expense ratio means for individuals

Post by Khanmots »

I believe that all funds have an ER. It covers their cost for buying/selling the underlying shares, for providing the website, etc. Vanguard is owned by the people who own it's funds, so it's running at-cost... which is why they have really low ERs and many of us prefer them.

That said, there are some other fee structures that you'll find... on *top* of the standard ER.

Some funds will carry a front-end or back-end load (or both!) in addition to the ER. A load is a fee (as a % of the amount) that's paid at the time you purchase (front-end) or sell (back-end) your shares.
It's not always a bad thing... in some cases this is done when the fund is investing in a small market where there's significant costs to buying/selling the underlying securities and they're passing this cost on to the people who cause it to be incurred so they can keep the ER on buy-and-hold investors lower. In many cases though this is done as a money grab. There's a lot of 5% front-end loads out there... so you have $100 to invest and you only wind up investing $95, and you're still paying the ER.

As for how much you pay in the year, the mutual fund companies will keep the ER updated, but none of them report it as nominal dollars. I've never worried about what the exact dollar amount is. I know lower is better... and if I'm on the cheapest offerings, then that's all I need to know, not sure how knowing the dollar amount would help me.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Defining what an expense ratio means for individuals

Post by Tamales »

I thought the annual expenses were "deducted" right off the top of the total net assets of the fund. If annual fund expenses/fees are 1%, then 99% of the total net assets on any given day (call it the expense-adjusted net assets) is the figure used to determine the daily NAV. So it's already baked in to the per-share prices available to the public. Is that not correct?

edit: in the example listed here: http://wiki.fool.com/How_Am_I_Charged_f ... e_Ratio%3F
expenses are taken from dividend payouts.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

Tamales wrote:I thought the annual expenses were "deducted" right off the top of the total net assets of the fund. If annual fund expenses/fees are 1%, then 99% of the total net assets on any given day (call it the expense-adjusted net assets) is the figure used to determine the daily NAV. So it's already baked in to the per-share prices available to the public. Is that not correct?

edit: in the example listed here: http://wiki.fool.com/How_Am_I_Charged_f ... e_Ratio%3F
expenses are taken from dividend payouts.
Well 1% divided by 365 days in a year is 0.00274% per day. A fund was worth $100. At the end of the day, the market was up and the fund was up $10, so the new NAV will be $109.997, but will be reported as $110 (I charged the 0.00274% against the starting NAV of $100).

Rinse and repeat for the rest of the year (but don't use 365, use the number of trading days, I think).

If the NAV is stuck on $100 for the whole year, the charge will be roughly $1. (Since the balance is slowly declining, the NAV will be $99.50 at some point, so the total charges will be less than $1, the final NAV being slightly more than $99). Note, I make stuff up, but I think this is pretty close to the truth.

P.S. Dividend payouts are also taken from the NAV. Expenses are paid from income, and dividends are paid from income. More of one means less of the other.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

So here is another version of the truth. The SEC has a formula that funds are required to use to compute the ER. The formula starts with actual dollar expenses, past or estimated. The ER is the end result, not the beginning. The cost of toilet paper is deducted every day from the NAV, not just the days the fund goes to Costco to buy toilet paper; in other words, they smooth the costs out.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: Defining what an expense ratio means for individuals

Post by dbr »

SeaGhost wrote:
Thank you for your reply. Sounds like your first sentence is in agreement with dbr. It still sounds a bit complicated. Do companies like Vanguard make it clear how much money you actually paid in fees in a year through the ER? It sounds like in my simplified example, the person could have paid a wide range of fees related to the expense ratio, depending on if their $10,000 of annual contributions became $5,000 or $15,000.
There is a difference between billing the shareholders of the fund for the costs to run the fund and charging shareholders a fee. ER is supposed to be expenses, and, as explained above, there can also be fees. Sometimes there is a fee in the ER, namely a 12b-1, if one exists.

Yes, your losses to costs (and fees) expressed as a fraction of assets are proportional to what you have invested over time. No fund company tabulates individual results. Also for details you can read the fund annual reports and reports of supplemental information.

While on the subject, it might interest you to know there are other fund expenses and income that are netted against the NAV but not reported in the ER. One is brokerage costs to the fund for buying and selling securities and another is income from securities lending. To cut brokerage costs you want a fund with little turnover, which is usually the case with index funds.

If you are thinking that mutual funds are fertile field for ripping off investors, then you are absolutely correct, which is why so much attention is paid here to costs.
placeholder
Posts: 8421
Joined: Tue Aug 06, 2013 12:43 pm

Re: Defining what an expense ratio means for individuals

Post by placeholder »

SeaGhost wrote:Would it be considered a rip off if they just took 1% of the principal every time you bought funds and does any company use this kind of model?
That would be a huge penalty for short term investors and quite the boon for long term as you can see by thinking about an investor that holds the fund for one year and one that holds it 50 years and of course that 1% over 50 years probably would not come close to covering the expenses it is supposed to.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

SeaGhost wrote: Would it be considered a rip off if they just took 1% of the principal every time you bought funds and does any company use this kind of model?
Forty years ago an investment in TIAA Traditional was subject to a 3.5% charge (to cover expenses and contingencies during the lifetime of the contract) and an investment into CREF Stock was subject to a 1.75% charge (to cover operating expenses during accumulation).

In 1982, those were dropped and replaced with charging operating expenses against earnings on an annual basis.

Since these were intended to be 30 and 40 year investments, I am not sure who won (following placeholder's logic, which I agree with).
an_asker
Posts: 4903
Joined: Thu Jun 27, 2013 2:15 pm

Re: Defining what an expense ratio means for individuals

Post by an_asker »

sscritic wrote:
SeaGhost wrote: Would it be considered a rip off if they just took 1% of the principal every time you bought funds and does any company use this kind of model?
Forty years ago an investment in TIAA Traditional was subject to a 3.5% charge (to cover expenses and contingencies during the lifetime of the contract) and an investment into CREF Stock was subject to a 1.75% charge (to cover operating expenses during accumulation).

In 1982, those were dropped and replaced with charging operating expenses against earnings on an annual basis.

Since these were intended to be 30 and 40 year investments, I am not sure who won (following placeholder's logic, which I agree with).
I don't know who won either, but I know who lost. The last dudes who bought it in the 1981-82 timeframe paying the up-front charge and held on for a few years paying the annual operating expenses! :oops:
pkcrafter
Posts: 15461
Joined: Sun Mar 04, 2007 11:19 am
Location: CA
Contact:

Re: Defining what an expense ratio means for individuals

Post by pkcrafter »

Vanguard has super-low expense ratios on their index funds because they are a not-for-profit company--the only not-for-profit mutual fund company. You should also be aware that fund total returns are reported after the expense ratio has been deducted. High costs are a drag on returns as shown by the chart above, but the drag isn't very noticeable in the short term, but over your investment lifetime they add up to very significant losses.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

pkcrafter wrote:Vanguard has super-low expense ratios on their index funds because they are a not-for-profit company--the only not-for-profit mutual fund company.
TIAA.
TIAA has no outside shareholders, other than our Board of Overseers, which is a not-for-profit entity. Importantly, according to TIAA’s corporate charter, TIAA functions without profit to the corporation or its shareholders. That means that TIAA can use operating earnings to fortify the overall organization. As a result, our corporate interests are directly in line with those of our clients​.
an_asker
Posts: 4903
Joined: Thu Jun 27, 2013 2:15 pm

Re: Defining what an expense ratio means for individuals

Post by an_asker »

pkcrafter wrote:Vanguard has super-low expense ratios on their index funds because they are a not-for-profit company--the only not-for-profit mutual fund company.[...]

Paul
I agree with everything else you say but disagree with the above. I could create my own not-for-profit mutual fund company and pay each of my managers (and myself, of course) a billion buckaroos a year - and still be a not-for-profit company. But I wager that my firm's expense ratio will surpass Vanguard.

Or I could create the least expense ratio company as well. Let's say I would employ the electronic age of Pony Express while everyone else uses FedEx; my fund managers will travel by bicycle for their interviews and sleep in the local farmer's barn. I will let your imagination go wild on what kind of a mutual fund manager I will get for my firm, and how well my fund will move with the market. But believe you me, the ER of my mutual fund will be a tenth of Vanguard's! :oops:

TLDR: The mutual fund with the least expense ER might not necessarily be the best (and anyway, Schwab does have lower ERs on some indices); and the not-for-profit company moniker could be a red herring.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Defining what an expense ratio means for individuals

Post by Tamales »

Khanmots wrote:
Here's an example.
Two different S&P 500 funds. Both invest in the same exact thing.

One has an ER of 0.05%
One has (had?) an ER of 2.28%

Image

Notice that the two go up and down completely in sync... they're investing in the same stuff after all. There's just a huge drag on the Rydex fund (realize that's a log scale!) That's the affect of a high expense ratio.
Then wouldn't it be the case that what you should really look at (for funds tracking the same index) is an overlay of their charts, where the expenses are already included in the results you see?

If the expenses were different in the Vanguard 500 and Rydex 500 comparison graphs above, and let's say the vanguard 500 had 4% expenses vs 2.3% for Rydex but the charts still looked the same as above. Wouldn't that say you should still buy the Vanguard in spite of the higher expenses?

And if that's the case you can essentially ignore the expense ratio as a decision factor, and just choose the one with the better total return performance regardless of the expense ratio differential?

And further, if (in a hypothetical comparison of 2 funds investing per the same index) the 2 funds overlaid exactly, you might be tempted to favor the one with lower expenses. But since their total return graphs overlay exactly you can really just flip a coin, no matter how far apart their expense ratios are?

I'm probably missing something...someone set me straight.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

The following are impossible:

They hold the same stocks and have different ERs, but match each other on a return chart.
They hold the same stocks and have the same ERs, but don't match each other on a return chart.
They hold the same stocks and have different ERs, but the one with the higher ER gives you higher returns on a return chart.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Defining what an expense ratio means for individuals

Post by Tamales »

sscritic wrote:The following are impossible:

They hold the same stocks and have different ERs, but match each other on a return chart.
They hold the same stocks and have the same ERs, but don't match each other on a return chart.
They hold the same stocks and have different ERs, but the one with the higher ER gives you higher returns on a return chart.
But none of them holds exactly the same stocks in exactly the same proportions, and/or other things they may hold that are in keeping with their (usually open-ended) objective. Many/most do statistical replication. Can result in a lot of trading/turnover.

It's mathematically possible that the one with the higher expense outperformed the one with the lower expenses, when looking at total return graphs.
It's also possible the one with lower returns has lower tracking error relative to the actual index, so tracking error isn't always a good measure either.
Last edited by Tamales on Wed Jul 23, 2014 1:04 pm, edited 1 time in total.
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Defining what an expense ratio means for individuals

Post by sscritic »

Tell me how the Vanguard 500 and the Rydex 500 differ. Look at the list of holdings by percent. What differences do you see?

Also, which one had more turnover?

My guess is that there isn't much difference, but I am willing to be convince by the data.

P.S. Which one holds only 300 stocks selected at random?
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Defining what an expense ratio means for individuals

Post by Tamales »

sscritic wrote:Tell me how the Vanguard 500 and the Rydex 500 differ. Look at the list of holdings by percent. What differences do you see?

Also, which one had more turnover?

My guess is that there isn't much difference, but I am willing to be convince by the data.
I was very clear I was making a hypothetical case re: vanguard 500 and rydex 500, but as I said it's mathematically possible two funds can target the same benchmark and the one with higher expenses could outperform. Holdings are a current 1-day snapshot. Doesn't tell you the daily changes in positions based on their statistical models which lead to changes in positions and/or weightings and/or cash or other seemingly small percent of total portfolio, but that is significant relative to expense ratios. There's nothing that can be done with than info in making the case you ask for. It's not enough data.

If I happen across such a comparison I'll post it, but I don't see why it's so hard to believe. If the higher expense fund, via its statistical subset of the index, happens to jump in and out of components that outperformed the averages across the index, it would have higher total return and higher expenses.
User avatar
Duckie
Posts: 9777
Joined: Thu Mar 08, 2007 1:55 pm

Re: Defining what an expense ratio means for individuals

Post by Duckie »

I'm late to the game, but:
SeaGhost wrote:I'm looking for how the expense ratio is charged to investors in practice. For example, if I invest $1,000 per month into a fund that has a 1% expense ratio, am I charged 1% of the principal each time I buy shares of the fund?
No, you're charged 1% on the entire value of your fund. If it's worth $100,000, 1% of that is $1000. If you buy $10,000 next year (and the price doesn't change) that will make the fund worth $110,000 and the fee will be $1100. 1% is a very high expense ratio.
Do companies like Vanguard make it clear how much money you actually paid in fees in a year through the ER?
Vanguard isn't dollar specific. If you look at the VTSAX page you just see 0.05%. If you look at the FSTVX page you'll see that Fidelity adds a little extra to their explanation of 0.05% ($0.50 per $1000). Either way you'll have to do the math yourself. Multiply the expense ratio by the dollar value of your holdings. $100,00 times 0.05% is $50. That's a lot cheaper than $1000.
Would it be considered a rip off if they just took 1% of the principal every time you bought funds and does any company use this kind of model?
Some funds charge a load/commission on every purchase (and sometimes on sales). That load is in addition to the expense ratios.
Geologist
Posts: 3057
Joined: Fri Jan 02, 2009 6:35 pm

Re: Defining what an expense ratio means for individuals

Post by Geologist »

Duckie wrote:
Do companies like Vanguard make it clear how much money you actually paid in fees in a year through the ER?
Vanguard isn't dollar specific. If you look at the VTSAX page you just see 0.05%. If you look at the FSTVX page you'll see that Fidelity adds a little extra to their explanation of 0.05% ($0.50 per $1000). Either way you'll have to do the math yourself. Multiply the expense ratio by the dollar value of your holdings. $100,00 times 0.05% is $50. That's a lot cheaper than $1000.
Vanguard is dollar specific, if you look in the semi-annual or annual report for a fund. In those reports, you will find tables showing actual expenses for each share class for the preceding six months based on actual returns and an assumption of 5% annual returns per $1000 invested in the fund.

Since people have been using the S&P500 index as an example, the 2013 annual report reveals that Investor shares had actual expenses of $0.93/$1000 invested for the 6 months ended 12/31/13, while Admiral shares had expenses of $0.27/$1000 in the same period. Double for annual expenses. I'm omitting the other share classes and the hypothetical 5% yearly return, but you can look them up.

This is not the only useful information appearing in these reports, which is why I recommend looking at them at least once in a while.
TareNeko
Posts: 585
Joined: Wed Aug 14, 2013 1:27 pm

Re: Defining what an expense ratio means for individuals

Post by TareNeko »

Tamales wrote:If the expenses were different in the Vanguard 500 and Rydex 500 comparison graphs above, and let's say the vanguard 500 had 4% expenses vs 2.3% for Rydex but the charts still looked the same as above. Wouldn't that say you should still buy the Vanguard in spite of the higher expenses?

And if that's the case you can essentially ignore the expense ratio as a decision factor, and just choose the one with the better total return performance regardless of the expense ratio differential?

And further, if (in a hypothetical comparison of 2 funds investing per the same index) the 2 funds overlaid exactly, you might be tempted to favor the one with lower expenses. But since their total return graphs overlay exactly you can really just flip a coin, no matter how far apart their expense ratios are?

I'm probably missing something...someone set me straight.
If 2 mutual funds are holding the exact same stocks (such as tracking an index, passively), the one with higher ER will have lower return. But if you mean to say that 2 mutual funds are in the same category (say, large cap) where the one with higher ER has also higher return, then your question (why not choose the high ER, high return one) makes sense. The answer is: past performance does not guarantee future performance.
pkcrafter
Posts: 15461
Joined: Sun Mar 04, 2007 11:19 am
Location: CA
Contact:

Re: Defining what an expense ratio means for individuals

Post by pkcrafter »

an_asker wrote:
pkcrafter wrote:Vanguard has super-low expense ratios on their index funds because they are a not-for-profit company--the only not-for-profit mutual fund company.[...]

Paul
I agree with everything else you say but disagree with the above. I could create my own not-for-profit mutual fund company and pay each of my managers (and myself, of course) a billion buckaroos a year - and still be a not-for-profit company. But I wager that my firm's expense ratio will surpass Vanguard.

I believe Vanguard can provide ultra-low ERs because it is non-profit, but I agree that you can create a not-for-profit company with higher fees.

Or I could create the least expense ratio company as well. Let's say I would employ the electronic age of Pony Express while everyone else uses FedEx; my fund managers will travel by bicycle for their interviews and sleep in the local farmer's barn. I will let your imagination go wild on what kind of a mutual fund manager I will get for my firm, and how well my fund will move with the market. But believe you me, the ER of my mutual fund will be a tenth of Vanguard's!
:oops:

Hmmm, I don't think you could. :happy

TLDR: The mutual fund with the least expense ER might not necessarily be the best

If it's an index fund and tracks it's index, it is

(and anyway, Schwab does have lower ERs on some indices); and the not-for-profit company moniker could be a red herring.
A red-herring? No. Schwab and Fidelity offer low cost index funds only to keep from losing customers to Vanguard, but these funds aren't generating profits for the company. These companies take the loss in order to get customers into more expensive products, although they probably curse the Bogleheads.

SS, thanks for the info on TIAA-CREF, I didn't know that. They may be not-for-profit, but there total market fund has an ER 8X Vanguards. Not terribly high, but probably due to being involved with insurance and higher costs.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
Tamales
Posts: 1644
Joined: Sat Jul 05, 2014 10:47 am

Re: Defining what an expense ratio means for individuals

Post by Tamales »

Erhan wrote:But if you mean to say that 2 mutual funds are in the same category (say, large cap) where the one with higher ER has also higher return, then your question (why not choose the high ER, high return one) makes sense.
That's a good point about same category. They wouldn't even need to track the exact same index (unless you had some reason to want to track a particular index) as long as they are in the same category. You probably want it to be a bit tighter than just the large cap category because for example there are large cap growth indices and large cap value indices and you couldn't rightly expect two funds tracking those to be a proper comparison since the indices themselves would be quite different if you overlaid them.

So does anyone disagree with a conclusion that expense ratio and tracking error comparisons aren't decisive on their own. The better comparison, it seems, is to overlay the two similar funds in question and if one clearly outperforms the other on a total return basis--even if it has higher expense ratio and higher tracking error--it's a viable candidate. It shouldn't be rejected just due to the higher expense ratio and/or higher tracking error, which are already factored in to the total return. I'm just not sure if there's something I'm missing, since this bucks the conventional wisdom you see in many books and articles stressing the importance of expense ratio considerations as a stand alone factor in selecting funds.

Here's an example. While not the greatest example, these ETFs are both large cap ex-US and both track the same MSCI ACWI ex-US index, but the one in blue (CWI) has very slightly higher expense ratio (.34 vs .33) and significantly higher returns over this period, compared to the green (ACWX). The blue one holds significantly fewer stocks to replicate the index compared to the green (616 vs 1190).

Image
ASUGrad
Posts: 259
Joined: Sun Oct 20, 2013 8:09 pm

Re: Defining what an expense ratio means for individuals

Post by ASUGrad »

Or I could create the least expense ratio company as well. Let's say I would employ the electronic age of Pony Express while everyone else uses FedEx; my fund managers will travel by bicycle for their interviews and sleep in the local farmer's barn. I will let your imagination go wild on what kind of a mutual fund manager I will get for my firm, and how well my fund will move with the market. But believe you me, the ER of my mutual fund will be a tenth of Vanguard's! :oops:
I highly doubt it would be tenths of Vanguard. There are fixed costs and variable costs even if people sleep in a farmers barn. If you are managing 100k per client with an expense ratio of 0.005(1/10 of VG's biggest funds) thats only $5. That isn't going to pay for the statements or the person who processes the initial paperwork for that one 100k client. It won't cover transaction costs for having to buy the stocks either, or to have someone answer the phone when they call with a question. Website, yea that isn't happening. You also have to file reports with the SEC. You have to pay for licenses. Vanguard can only pull off the ultra low expense ratios because they manage SO much money. If your workers don't even have offices, phones, or cars I highly doubt you are going to be able to pull in the tens to hundreds of billions or 'trillions' of dollars it would take to achieve the economies of scale Vanguard has. They are spreading those costs over a lot of assets.
Post Reply