Total expense ratio or TER comprises the total costs associated with managing and operating an investment fund. TER can drastically influence investment decisions, potentially rewarding those who understand its fine details with superior investment choices. Here’s what investors should know about TER, how it’s calculated and how it differs from gross expense ratio. A financial advisor can help you evaluate investments and select funds with low TERs.
Understanding Total Expense Ratio (TER)
TER encapsulates all of the direct costs that are deducted from a mutual fund or exchange-traded fund to pay for its operation and management. This may include the fees that the fund manager collects, other administrative fees, as well as marketing and advertising expenses known as 12b-1 fees.
These costs, which are expressed as a percentage of a fund’s average net assets, ultimately affect the returns the investors receive. As a result, a lower TER may hint at a potentially higher return on investment, piquing the interest of some investors.
For example, imagine investing $10,000 in two identical funds – one with a TER of 0.20% and the other with a TER of 1.20%. If each investment grew 6% per year over 30 years, the money in the fund with the lower TER would be worth over $13,000 more than the other.
How TER is Calculated
Calculating TER is not a complex task. Picture a fictional investor, Jane, who is reviewing an investment fund with total costs of $20,000 and total assets of $1 million. To find the TER, Jane would simply divide the total cost of the fund by the total fund assets, and then multiply that by 100. With a TER of 2%, Jane understands that every year, 2% of the fund’s total assets are deducted to cover the costs of managing and operating the fund.
Total Expense Ratio vs. Gross Expense Ratio
Despite sounding similar, total expense ratio and gross expense ratio (GER) are not the same. The GER of a fund refers to the total percentage of assets that cover operational and management expenses before any fee waivers and other reimbursements are applied. TER, on the other hand, is the expense ratio that’s ultimately charged to investors after those fee reductions.
Suppose you invested $10,000 in a fund with a GER of 2%. Your investment would incur $200 in fees, but the fund applies waivers and reimbursements that drop its GER by a half-percentage point. As a result, the TER is 1.5% and you end up paying $150 in fees.
Benefits of Using TER
Understanding TER shines a light on the costs affiliated with an investment fund, giving you a clearer picture of potential returns after expenses are deducted. Additionally, it allows investors to compare different funds more thoroughly. A seemingly small difference in TER can accumulate into substantial savings over time. By choosing funds with lower TERs, investors can retain a greater portion of their returns, potentially fostering long-term wealth growth.
Limitations of Using TER
Despite these practical benefits, TER shouldn’t be perceived as the best or the only tool for making investment decisions.
While TER encompasses the fund’s management fees, operational costs and other expenses, it may not capture all underlying costs, such as transaction fees and taxes. For example, a fund that frequently buys and sells assets will incur higher taxes than a passively-managed fund. The fund’s TER won’t cover those taxes. Investors should be vigilant in assessing the full scope of expenses to accurately evaluate a fund’s overall financial impact.
Also, relying solely on TER could divert attention from a fund’s performance. A low TER doesn’t guarantee superior returns. Balancing cost considerations with historical performance is essential for making informed investment decisions.
Bottom Line
Understanding the total expense ratio is an integral part of making mature investment decisions. While TER lends insight into the operational and management costs associated with an investment fund and can significantly affect fund performance and the investor’s returns, it’s not a one-size-fits-all solution for picking funds.
Investing Tips
- A financial advisor can help you build an investment plan and pick investments aligned with your goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s capital gains tax calculator can help you estimate how much you may owe when selling an investment. Keep in mind that assets sold less than a year after being purchased will be taxed at ordinary income tax rates. Those sold after more than a year receive the more favorable long-term capital gains tax treatment.
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