It’s a bit like a restaurant tip

Dining out is nice. But what makes it extra nice is having kind waiters that take care in making sure that one receives their order in an orderly manner. That’s when you genuinely want to tip them for their service. An expense ratio is a calculation which determines the amount one pays in management fees for their investments.

What is an Expense Ratio?

It’s a measurement meant to show how much of an asset’s value is used for operational expenses. Without complicating your life too much and giving you nightmares about high school algebra classes, you just need to know that an expense ratio is the result of a fund’s expenses for operations divided by the monetary value of the assets under management. This is calculated once a year, and it really varies depending on the fund. Factors which help determine the expense ratio are the size of the fund that is being managed, its asset class, and the strategy that is being used for investing. A higher expense ratio can be assigned to international funds, as the staff managing it is spread across the world.

expense ratio

Where’s my money?

Operational expenses are deducted from the assets in a particular fund, which means that the investor will receive less of a return. Luckily operating expenses are pretty set - if they are low, it is likely they will stay low, and vice versa. A low expense ratio can be calculated for a passively managed fund (like an ETF),  as it doesn’t need much work compared to an actively managed fund (like a mutual fund), which will require teams of analysts and researchers for its upkeep. Most of the money calculated within the expense ratio goes to the investment/ portfolio manager. The rest, a bit like your salary (sigh) goes to taxes, any legal expenses, accounting, etc. It’s important to know that the trading activities behind a fund are not included in the expense ratio. In other words, this isn’t a trader’s salary.

Do investing apps work the same way?

Investing apps are great for so many reasons. They open up the stock market to a more diversified public, they help people learn about investing, and they focus on the interface of the experience. One of the major pluses of investing apps is that they are usually low-cost in their management fees (many go for about a dollar a month with a subscription). On top of this they also allow for smaller investments, such as investing in fractional shares.

Why will your future self thank you

Nothing in life is free, but some things can always be found cheaper. It’s good to know that investing comes at a price, and it’s good to be aware what that price is, and how all the people involved benefit from an investment. This can also be a determining factor when choosing what to invest is, as expense ratios can seriously decrease an investor’s returns by a few significant percentages. But how good would it be if there was no extra fee on your investments?

Extra bits:

  1. Money laundering is legal in Japan. But not the type you have in mind: money can be nasty when it comes to bacteria. For this reason, any Hithachi bank ATM in Japan will clean your money before handing it out to you.

2. In an experiment, people in the U.S. stopped and picked up money from the streets only when they found a dollar or more.

3. Not that kind of ER...Expense ratio is also referred to as ER, or MER (Management Expense Ratio).