The annual expense ratio represents recurring management fees as a percentage of a mutual fund's assets. It shows what it costs the investment firm to operate the fund. The expense ratio represents the percentage of the fund's assets that go purely toward the expense of the daily operation of the fund. The fund's expense ratio is taken out of the fund's assets and lower its return to investors. An expense ratio of 0.5% per annum means that each year 0.5% of the fund's total assets will be used to cover expenses.
The major parts of the expense ratio are the management fee and the administrative cost.
- The investment advisory fee or management fee is the money used to pay the manager of the mutual fund.
- Administrative costs are the costs of recordkeeping, mailings, maintaining a customer service line, etc. These are costs that all funds have, but they vary in size from fund to fund.
- Some funds also charge a 12b-1 fee. The 12b-1 fee gets its name from the section in the Investment Company Act of 1940  that allows a mutual fund to pay distribution and marketing expenses out of the fund's assets. The original intent of a 12b-1 fee was to help market the mutual fund so that its assets would increase. A 12b-1 fee has also been used as a hidden way to pay brokers for using the fund. The SEC has limited the 12b-1 fee to 1% annually with maximum of 0.25% going to brokers. The 12b-1 fee (0.25%) is also often used by no-load fund families to purchase "shelf space" on a brokerage's mutual fund "supermarket" platform. These funds are then sold as "no transaction fee" funds; no-load funds not paying the fee are sold with a purchase fee.
There are different kinds of expense ratios that investors should watch out for.
- Prospectus Gross Expense Ratio - Gross Expense Ratio represents the total gross expenses (net expenses with waivers added back in) divided by the fund's average net assets. If it is not equal to the net expense ratio, the gross expense ratio portrays the fund's expenses had the fund not waived a portion, or all, of its fees. Thus, to some degree, it is an indication of fee contracts. Some fee waivers have an expiration date; other waivers are in place indefinitely.
- Prospectus Net Expense Ratio - The percentage of fund assets used to pay for operating expenses and management fees, including 12b-1 fees, administrative fees, and all other asset-based costs incurred by the fund, except brokerage costs. Fund expenses are reflected in the fund's NAV. Sales charges are not included in the expense ratio. The expense ratio for fund of funds is the aggregate expense ratio as defined as the sum of the wrap or sponsor fees plus the estimated weighted average of the underlying fund fees.
- Audited Net Expense Ratio - The percentage of fund assets paid for operating expenses and management fees, including 12b-1 fees, administrative fees, and all other asset-based costs incurred by the fund, except brokerage costs. Fund expenses are reflected in the fund's NAV . This expense ratio is pulled directly from the fund's annual report. Sales charges are not included in the expense ratio. For fund of funds, the underlying fund expense ratios are not included in the expense ratio, although since January 2007 a fund of funds is required to report an Acquired Fund Fee that shows the operating expenses of the underlying funds. 
The table in the article sums up the best as to where to look for the different expense ratios.
|Prospectus Net ER||Audited Net ER||Prospectus Gross ER|
|Data Source||Fund Prospectus||Audited Annual Report||Fund Prospectus|
|Time period||Upcoming fiscal year||Previous fiscal year||Upcoming fiscal year|
The expense ratio familiar to American investors has many different iterations on global markets.
- Canada: The expense ratio is known as the Management Expense Ratio (MER).
- Europe and the United Kingdom: The expense ratio is known as the Total Expense Ratio (TER).
- Australia: The expense ratio is known as Management Costs.
Blended expense ratio
To compute a blended expense ratio across a portfolio, compute the expenses for each fund, sum the expenses, and then divide that sum by your total balance, as shown below:
In the example above, the blended expense ratio of 0.41% is calculated by dividing $32.40 (the sum of the expenses) by $8,000 (the sum of the balances).
- Mutual funds: additional costs
- Purchase fee
- Redemption fee
- Effect of Expenses on a Portfolio (viewable and downloadable spreadsheet}
- Investment Company Act of 1940
- Acquired Fund Fees And Expenses - AFFE
- What's in an expense ratio?, from fi360