Expense ratio

What an expense ratio is

The expense ratio covers the fund’s management fee, any distribution or service fees, and other operating costs. It appears in the fund’s prospectus and in the participant fee disclosure, both as a percentage and as a dollar cost per $1,000 invested. The same fund can be sold in several share classes with different expense ratios.

Why it matters to employers

Fund expenses are usually the largest part of what participants pay, and fiduciaries have to make sure the plan’s fees are reasonable for the services received. Small differences compound. In a Department of Labor illustration, a $25,000 balance earning 7% a year for 35 years grows to $227,000 with 0.5% in fees, but only $163,000 with 1.5% in fees, which is 28% less.

Example

A participant has $50,000 in a fund with a 0.40% expense ratio. She pays about $200 a year, taken from the fund’s returns. In a similar fund charging 0.90% she would pay about $450.

Common mistakes

• Comparing providers on administrative fees alone and ignoring fund expenses.

• Not asking whether a lower-cost share class of the same fund is available to the plan.

• Assuming a fund is low-cost without reading the fee disclosure.