# Expense Ratio: Definition, Formula, Components, and Example

> **Definition**
>
> An asset's expense ratio is how much of a fund's assets are used to administer and maintain the fund.

## What Is an Expense Ratio?

An expense ratio measures how much you'll pay over the course of a year to own a fund, expressed as a percentage of your investments. An expense ratio is calculated by dividing a fund's operating expenses by its net assets. For example, if you have $5,000 invested in an ETF with an expense ratio of .04%, you'll pay the fund $2 annually.

### Key Takeaways

*   The expense ratio is a measure of mutual fund operating costs relative to assets.
*   Investors pay attention to the expense ratio to determine if a fund is an appropriate investment (after fees are considered).
*   Expense ratios may also be expressed as gross, net, and after-reimbursement expense ratios.
*   Passive index funds will have lower expense ratios than actively managed funds or those in less liquid asset classes.
*   In general, expense ratios have declined as competition for investor dollars has increased.

![Expense Ratio](https://www.investopedia.com/thmb/gcr37NZvrjKJykXsiZ8Ikqm476U=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/expenseratio-Final-0ec56abb4fde4c30a850007d090f24d0.jpg)

*— Investopedia / Theresa Chiechi*

## Calculating the Expense Ratio

It's very rare to need to calculate a fund's expense ratio because a fund is required to furnish it in its prospectus. Additionally, because it is an important metric for investors, expense ratios are almost always found on a fund's website. But if you need to calculate it, this is the formula:  

$\begin{aligned} &\text{ER} = \frac{ \text{Total Fund Costs} }{ \text{Total Fund Assets} } \\ \end{aligned}$

Where:

*   **Total Fund Costs**: The total of all management, transfer agent, accounting, custodian, trustee, auditing, legal, interest, miscellaneous, and other relevant operating fees (does not include loads or commissions).
*   **Total Fund Assets**: The fund's net assets.

You'll need to locate the fund's operating expenses in its financial statements and net assets on its webpage (or financial statements).  

> **Fast Fact**
>
> Generally, the lower the expense ratio, the better it is for most investors.

## Components of an Expense Ratio

Most expenses within a fund are variable; however, the variable expenses are fixed within the fund because of how it is calculated. For example, a fee consuming 0.5% of the fund's assets will always consume 0.5%, regardless of how it varies.

In addition to the management fees associated with a fund, some funds have an advertising and promotion expense, referred to as a [12b-1 fee](https://www.investopedia.com/terms/1/12b-1fees.asp), which is included in operating expenses. Notably, 12b-1 fees within a fund cannot exceed 1% (0.75% allocated to distribution and 0.25% allocated to shareholder servicing), according to [FINRA](https://www.investopedia.com/terms/f/finra.asp) rules.

A fund's trading activity—the buying and selling of portfolio securities—is not included in its calculation of the expense ratio. Costs not included in operating expenses are [loads](https://www.investopedia.com/terms/l/load.asp), [contingent deferred sales charges (CDSC)](https://www.investopedia.com/terms/c/cdsc.asp), and [redemption fees](https://www.investopedia.com/terms/r/redemptionfee.asp), which, if applicable, are paid directly by fund investors.

> **Important**
>
> The expense ratio is often concerned with total net expenses, but investors sometimes want to use gross versus net expenses.

## Expense Ratios of Passive vs. Active Funds

The expense ratios of passively managed [funds](https://www.investopedia.com/terms/i/indexfund.asp) and [actively managed](https://www.investopedia.com/terms/a/activemanagement.asp) funds depend on how they are structured and managed:

*   Many ETFs and mutual funds are passively managed funds that track an index, which allows them to have very low fees.
*   There are several actively managed mutual funds and ETFs that have higher expense ratios because of their goals and strategies.
*   Many active and passive funds use asset-weighted strategies, which means they hold more assets from specific issuers or sectors than others based on a value comparison—leading to higher expense ratios than funds that don't use asset-weighting.

The Vanguard S&P 500 ETF (VOO), a passively managed index fund that replicates the Standard & Poor's (S&P) 500 Index, has one of the lowest expense ratios in the industry, at 0.03% annually. This fund does not use asset-weighting, but the Vanguard Consumer Staples ETF (VDC) does—and it has a much higher expense ratio: 0.10%. VDC mimics the MSCI US IMI Consumer Staples 25/50 index but weighs three sectors differently than the index.

The Fidelity Contrafund (FCNTX) is one of the largest actively managed funds in the marketplace, with an expense ratio of 0.39% ($39 per $10,000 invested). This fund is much more highly weighted toward communication services than its benchmark, the S&P 500.

> **Fast Fact**
>
> In general, exchange-traded funds (ETFs) have lower expense ratios than comparable mutual funds.

## What Does Expense Ratio Mean?

The expense ratio is the amount of a fund's assets used towards administrative and other operating expenses. Because an [expense ratio reduces a fund's assets](https://www.investopedia.com/ask/answers/07/mutual_fund_cost.asp), it reduces the returns investors receive.

## Why Is Expense Ratio Important?

The expense ratio of a fund or ETF [is important because](https://www.investopedia.com/articles/personal-finance/092613/pay-attention-your-funds-expense-ratio.asp) it lets an investor know how much they pay to invest in a specific fund and how much their returns will be reduced. The lower the expense ratio the better because an investor receives higher returns on their invested capital.

## How Is Expense Ratio Calculated?

The expense ratio is calculated by dividing a fund's net expenses by its net assets.

## The Bottom Line

Expense ratios are taken from mutual fund and ETF returns to help pay for operations and fund management. The expense ratio charged to investors will vary depending on the fund's investment strategy and level of trading activity. In general, expense ratios have declined steadily as competition for investor dollars has heightened.

Actively managed funds and those in less liquid asset classes tend to have higher expense ratios, while passively managed index funds [feature the lowest expense ratios](https://www.investopedia.com/articles/markets/102715/3-index-funds-lowest-expense-ratios.asp).

> **Article Sources**
>
> 1.  Financial Industry Regulatory Authority. "[Notice to Members 06-48: SEC Approves Amendments to NASD Rules 2210 and 2211 to Require Disclosure of Fees and Expenses in Mutual Fund Performance Sales Material](https://www.finra.org/rules-guidance/notices/06-48)."
>     
> 2.  U.S. Securities and Exchange Commission. "[Updated Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio](https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated)."
>     
> 3.  U.S. Securities and Exchange Commission. "[Investor Bulletin: Mutual Fund Fees and Expenses](https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins-20)."
>     
> 4.  Vanguard. "[Vanguard Consumer Staples ETF (VDC)](https://investor.vanguard.com/investment-products/etfs/profile/vdc#portfolio-composition)."
>     
> 5.  Vanguard. "[Vanguard S&P 500 ETF (VOO)](https://investor.vanguard.com/etf/profile/VOO)."
>     
> 6.  Fidelity. "[Fidelity Contrafund (FCNTX)](https://fundresearch.fidelity.com/mutual-funds/summary/316071109)."
>     
> 7.  U.S. Securities and Exchange Commission. "[Mutual Funds and Exchange-Traded Funds (ETFs) – A Guide for Investors](https://www.sec.gov/about/reports-publications/investor-publications/introduction-mutual-funds)."