Understanding Mutual Fund Expense Ratios
Sites like Morningstar enable you to compare mutual funds using their star rating system and their detailed data on the fund’s past performance as well as their expenses. The expense ratio is especially useful in determining the impact of the fund’s costs on your future returns. The problem is that the expense ratio doesn’t usually include certain costs that can negatively impact the fund’s long term performance. It is important to consider these additional expenses, not expressed in the expense ratio, to ensure your investment is not consumed by hidden costs.
- Sales charges or fund redemption fees: The commissions you pay, either on the front end or on the back end when you redeem your shares may not be factored into the ratio.
- Portfolio turnover rate: Funds that turnover their portfolios more frequently incur higher transaction costs which can eat into your return.
- Taxes: Funds that turn over their portfolio frequently can also incur more taxes on gains. And short term gains are taxed at a higher rate. Excessive taxation can also eat into your returns.
Alternatively, you could select only those funds that don’t charge sales loads and are more passive in their management. Index mutual funds, which are designed to track the performance of specific market indexes, are passively managed and their expenses are much lower.