What Is an Expense Ratio? | How Do Stocks Work?

An expense ratio is the annual cost of running a mutual fund or ETF, expressed as a percentage of the money invested in it. A fund with a 0.20% expense ratio costs about $20 a year for every $10,000 you hold.

How you pay it

You never get a bill. The fund deducts its expenses from its own assets a little at a time, so the cost shows up as a slightly lower fund value and slightly lower returns. The returns a fund reports are already net of its expense ratio, which is exactly why the fee is easy to overlook.

The ratio covers the fund’s ongoing costs: the manager’s fee, administration, legal and audit work, and in some funds marketing or distribution costs. It does not include the commission you might pay to buy the fund, or the bid-ask spread on an ETF trade.

In Canada: the MER

Canadian funds report a management expense ratio (MER). It bundles the management fee, operating expenses, and the sales taxes (GST/HST) charged on them. Mutual fund MERs can also include trailing commissions, ongoing payments to the dealer that sold you the fund. Trading costs inside the fund are reported separately as the trading expense ratio (TER). Both appear in a fund’s Fund Facts or ETF Facts document.

A worked example over 30 years

Two investors each put $10,000 into funds that earn 6% a year before fees, and neither adds or withdraws anything.

	Low-cost fund	Higher-cost fund
Expense ratio	0.05%	1.00%
Return after fees	5.95%	5.00%
Value after 30 years	about $56,600	about $43,200

A one-percentage-point fee difference costs about $13,400, nearly a quarter of the outcome, because the fee also removes the future growth that money would have earned. The arithmetic is explained in how compound growth works.

What to keep in mind

Cheaper is not automatically better, but costs are one of the few things you know in advance, while future returns are not.
Higher fees have to be earned back. The evidence on how often active managers do that is covered in active vs passive investing.
Index funds are cheap for structural reasons, as explained in how index funds work.

For advisory fees and the full picture, see how investment fees work.