Many mutual funds list two different expense ratios. Heres the difference between them.

Motley

Updated: Sep 22, 2017 at 11:16AM

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A mutual funds expense ratio tells you the percentage of a funds assets that are dedicated to running the fund. When researching mutual funds, youre likely to encounter two different numbers: gross expense ratio and net expense ratio. Heres what you need to know about mutual fund expense ratios in general and the difference between the two.

What is an expense ratio?

Basically, an expense ratio tells you how much (or how little) youre paying for the various expenses associated with running a mutual fund. An expense ratio is expressed as a percentage of the funds total assets, so if a particular mutual fund has $100 million under management and an expense ratio of 1%, the expenses of running the fund cost $1 million in the most recent fiscal year.

A mutual funds expense ratio includes three basic types of expenses:

  1. Management fees: Paid to the funds managers who decide how to invest your money. You may also hear this referred to as an advisory fee.
  2. Administrative fees: Covers such expenses as office rentals, administrative staff (such as secretaries), and other expenses not covered by the management fees.
  3. Advertising fees: The costs associated with marketing the fund to prospective investors, also known as 12b-1 fees.

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Gross expense ratio vs. net expense ratio

Simply put, a gross expense ratio includes all of the above expenses.

Many funds offer fee waivers and reimbursements in order to attract investors. In other words, funds can offer a temporary discount to the advertised fees. The net expense ratio is reflective of discounts like these.

In other words, the net expense ratio represents what investors actually paid during the most recent fiscal year. On the other hand, the gross expense ratio shows what they would have paid without the fee waivers or reimbursements, and what investors can expect to pay in the future if the discounts are discontinued.

Much of the time, the two numbers are the same. However, there are a lot of funds out there that will have two different expense ratios, as you can see from this screenshot, so its important to know the difference.

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Things to keep in mind
When examining the gross and net expense ratios of mutual funds, its important to keep in mind that any fee waivers or reimbursements that result in a lower net expense ratio may be temporary. Think of a lower net expense ratio like an introductory 0% APR offer on a credit card. Sure, it helps keep your interest expenses low at first, but its not representative of what it will actually cost you to carry a balance on the card on a long-term basis.

Similarly, while the net expense ratio might represent the cost of that fund right now, theres no guarantee thats what youll be paying next year, or several years down the road.

For this reason, the gross expense ratio is the more important piece of information to long-term investors, as it lets you know the fees you could have to pay, not just the attractive discount youll pay for the time being.

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