What is an Expense Ratio? An “expense ratio” is how much a mutual fund charges you to manage your money. Funds with low expense ratios charge about 0.3% per year. Funds with high expense ratios charge 2% per year – or more!
How They Invest. Low-expense funds, such as Vanguard, usually buy and hold a “basket” of stocks that represent a certain segment of the market. Mutual funds with high expense ratios trade stocks constantly, buying the ones they think will increase in value.
Random Chance. So mutual funds with high expense ratios must generate a higher rate of return, right? Actually, no. Studies have shown that mutual fund managers perform no better than random chance. And all that buying and selling means that taxes are higher. Not to mention the fees. So, in actuality high-expense funds perform much, much, worse.
Think it doesn’t matter? Consider this:
|$100,000 invested for 20 years – 10% return|
|Fund w/ Low Expense Ratio (0.3%)||Fund w/ High Expense Ratio (2.0%)|
Over 20 years, the difference is 37%. With taxes, it is even more! So, before you buy a mutual fund, know the expense ratio. It really matters.
Not convinced? I highly recommend reading A Random Walk Down Wall Street. And if you’re looking for a good place to find low-expense funds, I personally use and recommend Vanguard Mutual Funds, which have very low expense ratios.