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Expense Ratio
Definition
The expense ratio is the annual fee charged by a mutual fund or ETF to cover operating costs, expressed as a percentage of assets invested.
Explanation
Expense ratios cover management fees, administrative costs, and marketing expenses. A lower expense ratio means more of your money stays invested. Over long periods, high expense ratios can significantly reduce returns. Index funds typically have expense ratios below 0.10%, while actively managed funds often charge 0.50-1.50%.
A 1% difference in expense ratio over 30 years can reduce your final portfolio value by 25% or more.
Example
A $100,000 investment earning 7% annually for 30 years: with a 0.05% expense ratio = $741,000. With a 1% expense ratio = $611,000. The 0.95% difference costs $130,000.