Fund expense ratios and what a fee compounds to

How it works

The expense ratio is listed in the fund's prospectus and fact sheet, which the Securities and Exchange Commission requires, and it is deducted a little each day from the fund's assets, so it never appears as a bill. A ratio of 1 percent on $10,000 costs $100 that year, and the cost scales with the balance, so it rises as the account grows. Because the fee comes out every year, its effect compounds just as returns do. Over thirty years at a 7 percent return, a 1 percent yearly fee removes roughly a quarter of the final balance compared with a fund charging 0.1 percent, since the money taken each year also stops earning. A workplace plan's fund menu lists each fund's ratio, and the plan must disclose it.

What it gives

The ratio is published and easy to compare across funds that hold the same kinds of assets.

Low cost funds exist in every major asset class.

The plan or broker must disclose the fee, so it can be found for every holding.

What it costs, or where the catch is

The fee is invisible on statements, since it comes out of the return before it is reported.

A difference of one percentage point sounds small and compounds to a large share of a lifetime's savings.

A workplace plan's menu may offer only higher cost funds, with no way for the worker to change the menu.

A worked example

Yara and Zara each put $500 a month into a stock fund for 30 years, and the market returns 7 percent a year before fees. Yara's fund charges 0.1 percent, so she earns about 6.9 percent and ends with roughly $598,000. Zara's fund charges 1 percent, so she earns about 6 percent and ends with roughly $502,000. The $96,000 gap, which is $598,000 minus $502,000, is the fee and the growth the fee took with it.

Where it goes wrong

The common miss is picking a fund by its past return without looking at the ratio, when the ratio is one of the few numbers about a fund that is known in advance.

Who confirms it for you

Nobody has to; it is arithmetic you can check yourself with the numbers above.

The official source

Investor.gov: Understanding fees. Every figure that changes by year comes from the site's rules table, which the watcher checks against the official page on a schedule; where a figure is not yet verified, this page says so instead of printing a number.