Expense Ratios - How Do They Work?

[ItsDubC]

It is my understanding that an expense ratio w/ respect to a mutual fund is the cost of operating that mutual fund. How does this cost affect fundholders? More specifically, is the percentage expressed by a fund's expense ratio taken out before returns are given to fundholders or is it taken out of each fundholder's balance on a yearly basis?

Also, w/ respect to index funds, since a computer is taking the place of a manager to manage the fund, to whom does the expense ratio go to?

[disneysteve]

Re: Expense Ratios - How Do They Work?

I believe operating expenses are taken out on an ongoing basis throughout the year, not all at once. Stated fund returns are after accounting for expenses.

Even with index funds, there is human management, so the expenses are collected by them and the fund company.

[creditcardfree]

Re: Expense Ratios - How Do They Work?

Steve is correct that operating expenses are calculated on a daily basis on mutual funds. The fund calculates gross assets value minus expenses to result in the net asset value (NAV) of the shares every market day.

All mutual funds have an expense ratio which is spelled out in the prospectus usually in the first several pages and is titled annual fund operating expenses. You will notice when you start comparing index funds to other funds that their operating expense rations are significantly lower because the management fee is less. Assuming equal assets, lower expenses, would result in a higher return for you as a shareholder.

Expenses any fund (even an index fund) incurs include printing of statements, prospectuses, SEC filings, professional fees for independent accounting, shareholder recordkeeping, postage, salaries of customer service agents...ect.