Expense Ratio: Definition and a Simple Example

What does expense ratio mean?#

The SEC's Investor.gov glossary defines the expense ratio as the percentage of a fund's average net assets used each year to pay the fund's operating expenses. Those can include management fees, distribution and/or service fees (called 12b-1 fees), acquired fund fees and expenses, and other expenses^[1]. You will find it in the prospectus fee table^[1].

In that fee table it carries a longer name: Total Annual Fund Operating Expenses, expressed as a percentage of average net assets^[2]. Mutual funds and ETFs both have one; FINRA notes that ETFs have expense ratios but no loads or 12b-1 fees^[3].

What does it look like in dollars?#

Worked example

$5,000 in two funds with different expense ratios

Multiply the amount invested by the ratio for a rough first-year cost. A 0.20% ratio on $5,000 is about $10 a year; a 0.80% ratio is about $40. The $30 difference repeats every year and compounds over time.

Fund	Expense ratio	In basis points	Rough yearly cost on $5,000
Fund A	0.20%	20 bp	$10.00
Fund B	0.80%	80 bp	$40.00
Difference	0.60%	60 bp	$30.00

Figures computed in code from the stated inputs; rounded to the nearest cent or tenth.

What is not included?#

The ratio covers yearly running costs only. Sales loads are separate shareholder fees charged directly to you^[2], and brokerage commissions and bid-ask spreads come from trading. A fund's own trading costs are also outside it: Form N-1A says those transaction costs are not reflected in annual fund operating expenses but still affect performance^[4].

For the full explanation with a 30-year table, read expense ratios explained. To see where the number sits in a prospectus, read how to read a fund prospectus. Fund costs are often quoted in basis points, and the fee drag calculator shows a yearly cost over any period.

Sources

Numbers in brackets in the text point here. Grade A = primary source (regulator, statistics agency, law or official document).