On the surface of things, 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. Pay attention to expense ratios; they are an important aspect of mutual funds. An expense ratio is basically an operating fee charged to all mutual fund investors to cover the costs of the fund.
Gross Expense Ratio
The gross expense ratio of a mutual fund represents the cost of running a fund as compared to the profit earned by the fund. Gross expense ratio figures consider all of the expenses of a fund, including administrative, accounting, marketing and distribution costs and fees associated with investments made by the fund, among other expenses.
The Financial Industry Regulatory Authority, or FINRA, requires that all mutual funds publish gross expense ratios for the general public. These figures often appear on mutual fund websites and in published material such as pamphlets. You'll typically see the expense ratio expressed as a percentage of the fund's average net assets, rather than a dollar amount.
Read More: Does Mutual Fund Performance Include Expense Ratio?
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 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 which eat into your investment returns.
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.
Fee Waivers and Reimbursements
Mutual funds sometimes partially cover the costs of their own operations. In such instances, funds either waive fees associated with operating costs or they 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 do 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 are an incentive to investors.
Gross Expense Ratio vs. Net
The primary difference between gross expense ratio and net expense ratio lies in their effects on the investor. Gross expense ratio affects only the mutual fund itself. Net expense ratio reflects the amount of money paid by each investor for fund operating costs when compared to profit from the investment.
The difference between these two ratios comes down to how much of its own operating costs a fund absorbs and how much of those costs it charges investors. Where there's healthy competition in the market, expense ratios tend to fall as they have done dramatically over the past few years.
Read More: What Is a Good Expense Ratio?
Will Gish slipped into itinerancy and writing in 2005. His work can be found on various websites. He is the primary entertainment writer for "College Gentleman" magazine and contributes content to various other music and film websites. Gish has a Bachelor of Arts in art history from University of Massachusetts, Amherst.