"Expense ratio" may sound like something learned—and then forgotten—in high school math class, but it's a term any investor should include in their lexicon. Simply put, expense ratio is the cost associated with running—and therefore investing in—an ETF or mutual fund, says certified financial planner Rich Coppa, managing director of Wealth Health.
Passively managed investment vehicles such as exchange traded funds, which track an index, might not cost a lot to manage but others, such as mutual funds, do, he said.
The expense ratio includes custodial, trust and analyst fees, as well as accounting and legal fees, according to Coppa.
"It's really important for you to know what the expense ratio is because that eats into your return," he said.
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As most funds report performance on an after-fee basis, those operating expenses can remain "silent" unless investors research and seek them out. In addition, while loads and redemption fees—the sales charges for, respectively, purchasing or exiting a fund—are not technically part of expense ratio (or operating expense) they "are an additional expense to investing in that fund" and should be kept in mind.
"Overall the expense ratio is an important piece of what you get to take home," Coppa said. "It's not only after-tax returns that matter but after-tax and after-fees [return] that matters."