An expense ratio is the annual operating cost charged by a mutual fund or ETF as a percentage of its assets.
The ratio generally covers expenses such as portfolio management, administration, accounting, legal services, and shareholder reporting. A fund with a 0.20% expense ratio typically deducts about 0.20% of its average assets each year for operating costs, although the deduction is reflected gradually in the fund’s returns rather than usually appearing as a separate bill.
Expense ratios matter because they reduce the return investors receive. Two funds following similar strategies may produce different results when one has materially higher ongoing costs. Passive index funds often have low expense ratios because they follow rules instead of paying a manager to select securities, but costs vary widely across funds and strategies.
An expense ratio is not the same as a sales load, which is a purchase or redemption charge, or a brokerage commission. Investors should also check a fund’s prospectus for other possible costs, including trading expenses and account-level fees.