What the expense ratio doesn't tell you

March 21, 2008

I'm new to investing and have been told that it's important to look for mutual funds with low expense ratios. Does that measure factor in all a fund's expenses?

I'm new to investing and have been told that it's important to look for mutual funds with low expense ratios. Does that measure factor in all a fund's expenses?

Unfortunately, no. The expense ratio reflects fees that are based on the amount of assets in the fund, including outlays to compensate managers and advisers; costs to administer and operate the fund; and distribution and marketing expenses (known as 12b-1 fees). But many funds also charge sales commissions up front when you invest money (called loads) or fees if you later withdraw cash before a specified number of years has passed (redemption fees). Those aren't reflected in the expense ratio, and neither are the transaction or brokerage costs the fund pays to buy and sell holdings. So while the expense ratio is a helpful measure (the lower, the better), to get a more rounded picture of the cost to invest refer to the fund's prospectus.