Expense Ratios on Mutual Funds

[jIM_Ohio]

Quick question, so with the expense ratio fees...how is the deduction taken?

Is the expense ratio deducted from the total account balance within each fund, and if so, will the expense ratio deduction be shown as a deduction on my statement? (This is within a 401(k) if that matters)

Also, what is the normal time of the year when the Mutual fund deducts the expense ratio?

as another poster already replied, expenses for each fund are taken out each day-week-month-quarter-year by the fund.

The NAV of a fund (Net Asset Value) is calculated each day after trading closes. Expenses are taken out prior to NAV being calculated.

so if expense ratio is .5%, and there are 210 (5 days times 52 weeks) trading days each year, .005/260= .000019 is taken out for every dollar in the fund each day.

[sweeps]

Expenses are a factor which affect return, but I would hardly call them the most significant factor.

They are the most significant factor within an asset class in which the investor has control over. That is all, nothing more, nothing less.

If ER ratios were the driving factor behind performance, then it could be argued bond funds have lower returns than equities because they have higher expense ratios (bond funds usually have higher ER than corresponding equity funds).

Jim, you're comparing apples and oranges. The aforementioned studies compare stock funds to stock funds. You shouldn't compare the gas mileage of a Honda Accord to a bicycle, just like you shouldn't compare the expense ratio of a stock fund to a bond fund.

I would also add that as an investor, I have no control over a funds expenses or the returns of the fund. Suggesting an investor can control the expenses of a fund is misleading. You can control the expenses of the funds by selecting this fund or that fund, but once invested, the investor really has no bearing on the expenses.

You make it sound like fund expenses change daily. It is pretty rare for a fund to change its expense ratio in a significant way. If a fund does happen to increase its expenses, you can always switch funds -- it's not like you're locked in that fund.

These studies are flawed in that they don't choose specific funds, and just use indexes to prove their point.

The studies look at all funds within a particular asset class, including both index and managed funds. Is there a high-expense fund out there that beats a low-expense fund? Of course. But we're talking about averages here.

The typical day in June will be warmer than the typical day in May. Sure, occasionally a May day will come out on top. But if I'm planning a trip to the beach, I'm going to play the averages and choose June.

[Broken Arrow]

Hmm, sweeps beat me to most of it.

Jim, the irony here is that I believe we're ultimately coming to similar conclusions, but just describing it from different sides of the fence.

I just want to clarify that ETFs can indeed invest in equities. It's just a closed ended mutual fund and is traded on the floor. But as sweeps pointed out, this isn't one asset class vs. another (which I would not consider ETFs and passive mutual funds as the same class, by the way). On average, a fund with a higher ER would give the investor less NET return than a similar fund with a lower ER. Like the S&P 500 index funds from two brokerages, for example. And in that apples-to-apples comparison, yes, ER is the most significant factor to investors.

In the end, the index fund is a long term strategy that relies on the rules of averages. As you would agree, for the casual investor, that works well enough. Those willing to put forth the effort for the technicals and fundamentals should look elsewhere.

[jIM_Ohio]

It's not? Does that mean rebalancing is not part of the expense then?

rebalancing will be cheapest if done in one of two ways

1) new contributions used to rebalance
2) dividends and capital gains are not reinvested, instead are used to go to cash (short term) and rebalance

so the target date funds will rebalance, but they will be doing so by using the above two techniques more than selling off their winners and buying the slower performing asset classes.

[sweeps]

This is off-topic but how does an investor determine that he has enough skill and time on his hands to pick managed funds over index funds? And then the follow-up to that is how does he know that he has so much skill and time on his hands that he shouldn't be in funds at all and should be picking his own stocks?

[jIM_Ohio]

This is off-topic but how does an investor determine that he has enough skill and time on his hands to pick managed funds over index funds? And then the follow-up to that is how does he know that he has so much skill and time on his hands that he shouldn't be in funds at all and should be picking his own stocks?

My opinion is close to 2 hours per month (24 hours per year) is where the threshold appears for the managed vs index question.

Some months I spend more time (close to 8-12 hours), some months I never look at all. If a person wants to spend as little time as possible, then target date or index funds look acceptable.

The stock issue is more for tax planning, IMO. If taxes are more the consideration, then investing in a mutual fund which the investor has no control over distributions is the driving factor.

For this reason, I suggest people consider stocks for taxable accounts- even if they own mutual funds in retirement accounts.

[disneysteve]

The stock issue is more for tax planning, IMO. If taxes are more the consideration, then investing in a mutual fund which the investor has no control over distributions is the driving factor.

For this reason, I suggest people consider stocks for taxable accounts- even if they own mutual funds in retirement accounts.

A couple of other points:

Instead of individual stocks, you could choose ETFs which give you instant diversification and still give you control over when you buy and sell for tax purposes.

If, however, you invest small amounts over time, as with dollar cost averaging, mutual funds are often the better way to go since there are no transaction fees. Even with a really low cost broker, say $4/trade, that is still $48 in fees if you buy once/month.

[Broken Arrow]

Interesting question, sweeps! Perhaps, in the end, it's a subjective matter of opinion.

For example, my sister had no trouble investing in emerging Chinese funds. In fact, she boasted a near 100% return! When I asked her what her valuations and fundamentals are for the fund, she shrugged, mumbled something, and then indicated that she's pulling out of that fund soon.

Bottom line is, given an arbitrary amount of time, effort, and information, some people may look that and decide that it is enough to invest on, whereas someone else looking at it may feel differently. For my sister, it was good enough to buy the fund, but for me, it would not be.

I would also think that part of the answer lies in what kind of investor we are. Depending on preferences and skill level, we have passive index funds on one end of the spectrum, and day traders on the other....

Truth is, I'm not even sure actively managed funds are the way to go. Very few people have, over the long term, beaten the market. Even Bill Miller and Peter Lynch have had rough years recently. And that's assuming that your fund managers are diligently working on fund performance, rather than just chasing after commissions.

Oh, and let me add that it's not so much that I doubt their abilities. But for us little people looking to invest in their funds, our own returns are watered down because of expenses and fees. I wonder if Peter Lynch had to pay for his own expense ratios? That'd be funny if he did. That and, by law, active fund managers have to diversify their portfolio a certain way (nothing below 5% or something like that), and they have to worry about short-term fund performance (because, sadly, too many casual investors look at that to determine what they should or should not buy).

The only person I currently know of that has a market-beating annual AVERAGE of 24% return is Warren Buffet. And his method makes sense to me. Slim down diversification, take on more risks, but mitigate that risk with due diligence.

Still, the bottom line to your question is, "I don't really know". All I can do is speak for myself, and speaking for myself, I am finally getting comfortable enough to begin putting my money on the line.

Perhaps it's one of those "You'll know when you're there" deals?