When it comes to saving for retirement, it's common to encounter fees, and the expense ratio is one of the most common. These fees cover costs associated with managing your investments. The expense ratio is calculated by dividing a fund's operating expenses by the average value of its net assets.
In this article, we'll break down what you need to know to better understand expense ratios, including:
How expense ratios work
How expense ratios can impact your investment decisions
What a reasonable expense ratio looks like
What a good expense ratio is for a 401(k)
Let's get started.
What is an expense ratio?
An expense ratio is essentially the cost of investing in a pooled investment vehicle like a mutual fund or exchange traded funds (ETF). A mutual fund or ETF (we will just refer to both of these as "funds") is a collection of individual assets like stocks or bonds that are managed by a fund company. Because they are already a mix, these funds help an investor diversify their investments.1
It's helpful to think of the expense ratio as the fee paid to the fund company for their management of the fund. It covers things like administrative fees, legal services, marketing and distribution costs. The expense ratio is the total of all of these fees charged by the fund.
How are expense ratios charged?
An expense ratio is shown as a percentage and is charged on your average net investment in that fund. For example, if you have an expense ratio of 0.30%, you'll pay $3.00 annually for every $1,000 you invest in the fund.
These fees will not appear on your account statement as the fund manager will factor these expenses in their fund value.
What's the difference between an expense ratio and a management fee?
As we mentioned earlier, the expense ratio is determined by the fund's manager and factored into the value of the fund.
A management fee — sometimes called an Assets Under Management fee or AUM fee — is typically what an Investment Advisor will charge for managing your individual portfolio. Typically, the more personalized and actively managed a portfolio is, the higher that fee may be.
How will an expense ratio impact my returns?
A high expense ratio can eat away at your returns long term. The more you pay in fees, the less money you'll have invested in your account.
Since retirement investments are intended to be long-term investments, a low expense ratio may help you potentially grow your retirement investment by saving on fees, assuming performance is similar. Fees add up over time and can significantly impact your retirement savings.
What is a good expense ratio for a 401(k)?
Expense ratios can vary among 401(k) providers and the funds that are offered. To see Gusto Investment Services’ most up to date expense ratios, click here.
Who is responsible for choosing funds with reasonable expense ratios?
Federal law says retirement plan providers have a fiduciary duty which requires them to review plan fees for reasonableness, which includes reasonable expense ratios for plan investment options. Congress created the Employee Retirement Income Security Act (ERISA) so that fiduciaries have strict rules of conduct, including keeping expenses reasonable, managing the plan only in the interests of participants and beneficiaries, diversifying investments and following the plan's governing documents.
How can I account for expense ratios in my investment plans?
If you generally aim for low expense ratios, the plan and your participants will likely pay less in fees. The money saved from not having to pay fees can potentially add up to bigger retirement savings.
Disclosures
1 Diversification does not ensure a profit or guarantee against loss.
2 Not investment advice. Gusto Investment Services LLC’s managed portfolios have blended expense ratios ranging from .058% to .061% of assets under management. When combined with an assumed account fee of 0.25% charged by Gusto Investment Services, LLC, estimated total AUM fees for one of the managed portfolios can be under 0.31%. See Form ADV 2A Brochure for fee info. Expense ratios subject to change by and paid to the fund(s). View full fund lineup here.
