Expense Ratio

The expense ratio measures how much of a fund's assets are used for administrative and other operating expenses. For investors, the expense ratio is deducted from the fund's gross return and paid to the fund manager.

An expense ratio is determined by dividing a fund's operating expenses by the average dollar value of its assets under management (AUM). Operating expenses reduce the fund's assets, thereby reducing the return to investors.

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Why Is 'Expense Ratio' the Term of the Day?

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Earlier this month, Cathie Wood’s Ark Investment firm lowered the expense ratio on its new ARK Venture Fund (ARKVX) to 2.9% from 4.2%.

The fund had about $15 million in net assets at the end of March, much less than many of ARK’s other products. The firm’s flagship ARK Innovation ETF (ARKK), for example, had $7.79 billion in assets under management. The firm is waiving its management fee through November 2024 and reimbursing the fund manager any expenses exceeding 2.9% of the fund’s average daily net assets, effectively capping its expense ratio at 2.9%.

Lowering a fund’s expense ratio is one way of spurring inflows, because a fund’s expenses can have a huge impact on an investor’s total return. For example, imagine you put $10,000 in a fund that’s expected to return 7% every year. If that fund’s expense ratio was 0.1%, you’d have about $19,488 after 10 years and would pay $183 in fees. But if that fund’s expense ratio were 0.5%, you’d pay $900 in fees and have only $18,771 after 10 years.

Expense ratios are often higher for actively managed funds because the fund’s investments are being directed by a person who is compensated accordingly. On the other end of the spectrum, passively managed funds, like index funds, usually have the lowest expense ratios.

-Colin

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