“I truly believe that the reason people don’t live out their ideal life...is because they don’t know where to learn.”
— Stephen Alred Jr.

Term of the week: Expense Ratios

As you invest in mutual funds or ETFs in your brokerage account, 401(k), or IRAs, you have probably seen a number represented as a percent called an "expense ratio" (i.e. 0.65%). Fees are a big inhibitor to your wealth growth over time and you want to pay close attention to the expense ratio of any fund you are/will be investing in.

An expense ratio is a fee that an investment fund charges for you to have assets within the fund. This fee is comprised of the fund's costs to manage your money. These costs range from the pay of fund's manager to the costs of legal expenses.

The special thing about an expense ratio is that it is not directly billed to you. Instead, it is taken out of the fund's managed assets. This is why many investors don't realize that there is a cost to investing in mutual funds OUTSIDE what they are paying for a financial advisor.

It is also the reason that most financial bloggers (people who aren't paid by their clients) recommend Vanguard ETFs. Vanguard funds have some of the lowest expense ratios in the industry due to their enormous scale and passive investing strategy. Since a large portion of an expense ratio goes to the fund manager, with a passive strategy the fund follows an index and isn't actively managed by an investment manager.

Want to know how drastically the fees affect you? Here's an example:

Let's say you are 33 years old. You and your spouse have done a great job saving and have amassed $100,000 in your investment accounts. You decide to continue investing $15,000 per year, for the next 30 years. On the one hand, you can invest in index fund  A with an expense ratio of .05%, on the other you can invest in fund B with an expense ratio of .55%. 

If we assume an annual rate of return at 7%. At age 63, fund A will have cost you around $23,000. Fund B...approximately $242,000. That is a $219,000 difference!

Moral of the story. Pay attention to your expense ratios. These hidden fees can be detrimental to your retirement plans. 

Q&A: Should we combine accounts when we get married?

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