When you compare mutual funds as investment choices, the expense ratio is an important consideration. The expenses the mutual fund company charges against the funds portfolio directly affect the return the fund provides to investors. The difference between net expense ratio and weighted average expense ratio is an expression of how the mutual fund is organized and functions.
Fund Expenses Defined
The administration of a mutual fund incurs several types of expenses. A major expense is often the advisory fee paid to the portfolio manager of the fund. Other expenses include administrative costs, such as tracking shareholder account information and mailing statements. A separately listed expense for marketing and distribution is referred to as a 12b-1 fee, which is also included in the total expenses. A fund is required to report its total expenses in its prospectus. The expense ratio is listed as a percentage of the mutual fund's portfolio value.
Net Expense Ratio
The published net expense ratio is the actual portion of a fund's assets taken by the fund sponsor to manage the fund. A fund may list a gross expense ratio and a smaller net expense ratio. Lower net expenses means the mutual fund company is absorbing some of the actual costs of running the fund. Mutual fund net expense ratios range from a low of about 0.10 percent up to 2 percent or more of a fund's assets. The Investment Company Institute reported in the 2012 Investment Company Factbook that the average net expense ratio based on assets under management -- a weighted average -- for stock mutual funds was 0.80 percent in 2011.
"Target date," "lifestyle" and "fund of funds" mutual funds are combinations of shares from a number of mutual funds packaged into single funds. These products provide asset allocation into stock, bond and internationally focused mutual funds in a single package. They typically are used as single investment choices for long-term retirement accounts and the asset allocation between different fund types is adjusted as the target retirement date approaches. A lifestyle mutual fund is put together by a mutual fund company using different funds from its own family of mutual funds.
Weighted Average Expense Ratio
The term weighted average expense ratio applies to lifestyle or fund-of-funds mutual funds. The expenses of one if these funds is calculated using the net expense ratio of each individual mutual fund included in the fund in the proportion of each fund used. The proportionality is the weighted part of weighted average. When a mutual fund company puts together a lifestyle fund, it does not add another level of expenses. The only expenses are the expense ratios of the included mutual funds.
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