Jim Dahle explains expense ratios and basis points, showing how investment fees eat into your returns. He covers typical fee ranges and why choosing low-cost funds matters for your long-term wealth.
Today's topic is about expense ratios. We want to make sure we continue to expand your financial vocabulary here and today the goal is to understand the important term of expense ratios. Both individual investments and the accounts that hold those investments can have all kinds of fees to be aware of. There are sales loads, broker commissions, advisory fees, account fees, management fees, redemption fees, transaction fees, 12 B1 fees. It is a cavalcade of fees out there. Today we are going to talk about just one of those types of fees, the one I think you probably read about and hear about most often at WCI as it relates to investment choices, which is the expense ratio. An expense ratio is a measure of a mutual fund or exchange traded fund's operating costs relative to its assets. It is determined by dividing a fund's operating expenses into its net assets. Operating expenses reduce the fund's assets, thereby reducing the return to investors. Because the expense ratio is deducted from the fund's gross return and paid to the fund manager, you never have to calculate the expense ratio. It will always be provided in the fund's prospectus. You can also just Google it if you know the ticker symbol for the fund in question. It's available on analytics sites like Morningstar or Yahoo finance. Good and ethical 401k custodians will provide the expense ratio right on the statement or website where you're looking at the investment options. In financial conversations you will sometimes hear expense ratios expressed as basis points or bips. For short written out bips is bps. When I say basis point that is referring to 1/100th of a percentage point. It is the cost of the investment expressed as a percentage. If you have an investment that has an expense ratio of 0.12% that is the same as saying the fund has an annual fee of 12 basis points. That means you owe 0.12% of the value of your investment each year to the firm that created the investment, like Vanguard or Fidelity. If Your investment is $100,000, you owe 120 bucks as the expense ratio. 12 basis points is a very low cost fund. Sadly, most of the mutual funds and exchange traded funds out there are not low cost funds. It is not uncommon for me to review a client's list of available funds in their 401, 403 or 457 and see that all of the options have expense ratios of 1% or higher. In other words, the fees are 100 basis points and up. When I was working at the Public Health Dental Clinic in Oregon, we had funds in our 457B with 240 basis point fees. That is a ridiculous 2.4% expense ratio. If I had $100,000 in that fund, they would charge me $2,400 each year just to own the fund. Imagine my returns for the year in that fund were 5%. That means the expense ratio consumed a whopping 50% of my investment return for the year. Thus, keeping expense ratios of your investments low should be a goal for any savvy investor. Fortunately, there has been a lot of pressure to lower expense ratios since since John Bogle started the index fund revolution at Vanguard in the mid-70s. Today there are many wonderful, tax efficient, highly diversified low cost funds available at places like Vanguard, Fidelity, Schwab, et cetera. Fidelity even offers their so called zero funds that have an expense ratio of zero. Funds like this can be compelling to people once they learn about expense ratios. Now some folks can become a little obsessive about whether the fund costs 7bps or 9bps. Don't worry about that. Don't become that person. At WCICON 2024 in Orlando, during Jim's talk on index funds, he said anything below 20 basis points doesn't matter. The goal is not to go from nine basis points to seven. The goal is to go from 145 basis points to nine. If you don't know the expense ratios on the funds you are using, go find out. A good investor always knows what they are paying for their investments. Good luck there you guys. You got this.
This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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