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Mutual Funds/Expense Ratios and Net Asset Values



If I understand correctly, the annual expense ratio on a mutual fund is not taken from the investors account but from the net asset value of the mutual fund.  How is this done?  If a mutual fund has a 0.75% expense ratio, how does this percentage change the net asset value?

I thank you for your reply.

ANSWER: Hi. This is a great question and something many people wonder about. I will give an example to help illustrate - lets say there are 2 identical mutual funds, fund A and fund B and they both return 10% in a year. However, fund a has an expense ratio of .50% and fund B 1%.

Fund A
$100000 initial investment
$10000 return (10%)
($500) expenses (.50%)
$109500 net value
9.5% net return

Fund B
$100000 initial investment
$10000 return (10%)
($1000) expenses (1%)
$109000 net value
9% net return

In other words, it isn't the net asset value price that gets adjusted per se and instead the fees are paid out of fund earnings before they are distributed to the shareholders and therefore your return is reduced accordingly.

I hope this helps clarify.

---------- FOLLOW-UP ----------


I want to thank you for the great reply!

Does this process, as you describe above, occur daily after the stock markets close?

I thank you again for your assistance and reply.

Hi. Youre welcome and I am glad my answer was helpful. In regards to your follow up, yes, my understanding is that there is a daily calculation that occurs in which this is netted out, although, I do not believe that fees are actually taken out daily (it all happens at the fund accounting level). Also, it is important to note that the stated fund expense ratio does not include additional costs the funds occurs such as trading costs. These come out of the fund as well, however, these costs are tied into the actual trading so there is no direct "fee" that the fund collects per se. I hope this helps.

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John D Smith, CFP


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