Mutual Fund Gross vs. Net Expense Ratio

Mutual Fund Gross vs. Net Expense Ratio
••• nuttapong punna/iStock/GettyImages

According to the Corporate Finance Institute (CFI), an expense ratio is a fee for operating expenses charged to all mutual fund investors. On the surface, investing in a mutual fund seems simple enough. You purchase shares in the fund, which entitles you to a share of fund profits in proportion to the number of shares you own. You should pay attention to expense ratios since they are an essential aspect of mutual funds and affect your rate of return.

What Is a Gross Expense Ratio?

The gross expense ratio of a mutual fund represents the cost of running a fund compared to the profit earned. It is different from a management fee. Gross expense ratio figures consider all of the expenses of a fund, including management fees and costs associated with accounting, marketing, distribution and legal fees. Trading fees, sales charges and brokerage fees are not included in the gross expense ratio.

The Financial Industry Regulatory Authority (FINRA) requires that all mutual funds publish gross expense ratios for the general public. According to the Securities and Exchange Commission (SEC), these figures can be found in the fund's prospectus under Shareholder Fees or Annual Fund Operating Expenses. The prospectus can be found on the fund company's website or in printed materials.

You'll typically see the expense ratio expressed as a percentage of the fund's average net assets rather than a dollar amount. For example, if a fund has a gross expense ratio of 1.5 percent, that means $15 of every $1,000 of fund assets are devoted to managing the mutual fund.

What Is a Net Expense Ratio?

Net expense ratio equals the gross expense ratio of a mutual fund minus acquired fee funds and any fee waivers or expense reimbursements made to investors by the fund.

Acquired fund fees constitute the costs, such as the total expense ratio, of mutual funds or similar securities and commodities in which your mutual fund invests. It includes all the things you see as deductions on your account – expenses that eat into your investment returns. The net expense ratio is what you will actually pay, and CFI explains it affects the net asset value of your mutual fund.

For example, if a fund has a net expense ratio of 1 percent, you will pay $10 for every $1,000 you have invested.

Net expense ratio affects shareholders directly, but gross expense ratio does not. However, FINRA doesn't require funds to publish this information for the public.

Mutual Fund Fee Waivers and Reimbursements

Mutual funds sometimes partially cover the costs of their operations. In such instances, funds either waive fees associated with operating expenses or reimburse investors for these costs. This practice is prominent in small mutual funds. Investors in small funds usually own a much larger percentage of a fund than investors in large funds.

Because of this, each investor pays a higher percentage of operating costs and thus reaps a smaller profit from investment. Small funds' waivers and reimbursements offer an incentive to investors.

Gross vs. Net Expense Ratio

The primary difference between the gross expense ratio and net expense ratio lies in their effects on the investor:

  • The ‌gross expense ratio‌ affects only the mutual fund itself.
  • The ‌net expense ratio‌ reflects the amount of money paid by each investor for fund operating costs compared to profit from the investment.

The difference between these two ratios comes down to how much of its operating costs a fund absorbs and how much it passes on to investors. Where there's healthy competition in the stock market, mutual fund expense ratios tend to fall.

Investor demand can also drive expense ratios down. According to Morningstar, average expense ratios across all mutual funds and actively managed ETFs was ‌0.40 percent‌ in 2021, less than half of where they stood 20 years ago. Much of the credit was attributed to investors seeking low-cost funds.

Expense Ratios: Mutual Funds vs. Other Funds

Index funds and passively managed exchange-traded funds (ETFs) tend to have lower expense ratios than mutual funds. Actively managed mutual funds and ETFs have high expense ratios because higher expenses are associated with having a fund manager monitor the fund. Passively managed funds are not managed by a fund manager, so there are fewer administrative fees and operating costs to pass on to investors.