Fund fees may seem small, but they can add up

ByABC News
May 8, 2008, 4:54 PM

— -- Q: If I own shares of an exchange-traded fund (ETF) or index mutual fund, how am I assessed fees?

A: One of the first things investors should look at, when evaluating mutual funds or exchange-traded funds, is the expense ratio.

The expense ratio is the percentage of your assets that are taken as a fee for the fund. For instance, if a fund charges a 0.5% expense ratio on your $100,000 account, you are paying $500 a year. As you can see, the fee is a significant factor. The fees are used to cover the expenses of running the fund, such as trading, legal, admistrative, printing, postage and other costs.

You don't get a bill from your fund company every year. In fact, the fee doesn't come directly out of your pocket. Instead, the fees are taken from the income or assets of the fund, says Linda Wolohan, spokeswoman for Vanguard Group, which offers funds and ETFs with some of the lowest fees in the industry.

For instance, a mutual fund may own shares of 500 stocks that pay an average dividend yield of 2%. That would be $2,000 on our hypothetical $100,000 portfolio. The fee of $500 would be taken from the $2,000 income, reducing what investors get.

And that's why it pays to pay attention to the fees your funds charge.

Last year, the average fee charged by the mutual fund industry was 1.22%, Wolohan says. That would be $1,220 on a $100,000 portfolio. Vanguard funds, on the other hand, had an average expense ratio of 0.2%, or $200 on the same $100,000. Over the years, that difference mounts, especially when subject to compounding.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.