What is a good expense ratio?

For a broad index fund, a good expense ratio is low: many charge under 0.10% a year, or under $10 for every $10,000 you hold. Above about 0.50% for a plain stock or bond fund is worth questioning, because a fee comes out every year whether the fund gains or loses.

It is a yearly percentage of your balance

The expense ratio is the share of a fund's assets used each year to pay its running costs, such as management, marketing and record keeping. Your cost in dollars is your balance times the ratio.

Low means under 0.10% for broad index funds

Broad index funds that track the whole US market, the whole world or a broad bond index often charge under 0.10%. Actively managed funds, where managers pick investments, commonly charge several times more.

Small gaps grow large over decades

Money paid in fees can't compound for you. A fund with higher costs has to earn more just to match a cheaper fund doing the same thing.

It is not the only fee

Some funds also charge sales loads or redemption fees, and some accounts add yearly account or adviser fees. Add them all up to see what investing really costs you.

What the expense ratio pays for

Every fund has running costs: the managers, the trading, the record keeping, the lawyers and accountants, and sometimes marketing. The fund passes those costs to its owners as a yearly percentage of assets. That percentage is the expense ratio.

It is taken out of the fund a little at a time, so the price you see already reflects it. That is why it is easy to miss. You will never see a line on a statement that says "fee: $340", but the money is gone all the same.

What counts as low or high

There is no official cutoff, but these ranges are a useful guide. For a broad US stock, international stock or bond index fund, under 0.10% is low, and some charge 0.05% or less. From 0.10% to 0.50% is middling for an index fund. Above 0.50% for a plain stock or bond fund is high and worth questioning.

Some funds cost more for a reason. A target-date fund bundles several funds and rebalances for you, so it may charge a bit more than a single index fund, often still well under 0.50% for index-based versions. Actively managed funds often charge 0.50% to 1% or more. A higher fee only pays off if the fund beats its cheaper rival by more than the fee, year after year, and that is hard to know in advance.

How to turn a percentage into dollars

Multiply your balance by the ratio. Move the decimal point two places to the left first: 0.85% is 0.0085. On $40,000, that is $40,000 × 0.0085 = $340 a year. At 0.04%, it is $40,000 × 0.0004 = $16.

As your balance grows, the dollar fee grows with it. A 1% fee on $200,000 is $2,000 every year. That is why a gap that looks small on a $5,000 balance is worth fixing early.

Where to find a fund's expense ratio

Look in the fund's prospectus, in the fee table near the front, or on its one-page fact sheet. For a 401(k), the plan website usually lists each fund's expense ratio, often in a fee disclosure chart.

You may see two figures. The gross expense ratio is the full cost. The net expense ratio is what you pay after any fee waiver the fund company has agreed to. Waivers can end, so note both. A fund that holds other funds may also list acquired fund fees, which are already included in the total.

What to do if your fees are high

In an IRA or brokerage account, you can usually sell a high-cost fund and buy a low-cost index fund. Inside an IRA or 401(k), that switch has no tax cost. In a regular taxable account, selling at a gain can mean capital gains tax, so you may prefer to send new money to the cheaper fund instead.

In a 401(k), you choose from the plan's menu. Scan it for funds with index in the name and compare their expense ratios. If every option is expensive, still take any employer match, which is worth far more than the fee costs, and consider an IRA for extra savings.