The expense ratio of a mutual fund measures how much of the pooled invested funds is devoted to the costs of running the mutual fund. As a result, the money devoted to costs is not invested into the investment pool and is thus not used for furthering a fund's income creation. Specifically, it is a ratio of the fund's total operating expenses to its average asset value. A fund's expense ratio is often a good indicator of its performance and quality.
Obtain the data needed for the expense ratio calculation. Specifically, you will need the mutual fund's costs, which include the management fee of total average assets, the 12b-1 distribution fee, administrative charges and the net expense ratio. In addition to costs, you will also need the average net asset value of the mutual fund. These figures can usually be obtained online from a variety of websites devoted to financial monitoring.
Add up all of the costs associated with your investment. This sum equals the total operating expenses of the mutual fund. Divide the mutual fund's total operating expenses by its average net asset value. This gives you the mutual fund's expense ratio. The expense ratio of most mutual funds lies in the range of .18 percent to 2 percent. This ratio thus represents the percentage of invested money that is not invested in the fund and is thus not converted into a profit.
Analyze your expense ratio. If it is relatively high, this does not mean that the mutual fund necessarily benefits from better quality management. On the contrary, the mutual fund may, in fact, be poorly managed as it is more focused on providing a profit for managers rather than its investors. Furthermore, a fund must make a return that is more than its expense ratio in order to provide a profit to its investors.