The total expense ratio (TER) is a crucial measure for evaluating the total costs related to managing and operating an investment fund, such as a mutual fund. These costs mainly include management fees, trading fees, legal fees, auditor fees, and other operational expenses.
The total cost of the fund is divided by the fund’s total assets to arrive at a percentage amount, known as the TER. It’s also referred to as the net expense ratio or after reimbursement expense ratio.
Key Takeaways
- The total expense ratio (TER) describes a mutual fund’s operating costs relative to its assets.
- It is a measure of a fund’s operational efficiency.
- Investors use the expense ratio to determine if a fund is a suitable investment after considering fees.
- TER is also known as the net expense ratio or after reimbursement expense ratio.
Understanding the Mechanism of the Total Expense Ratio (TER)
The size of the TER is crucial to investors as the costs are deducted from the fund, affecting investors’ returns. For example, if a fund generates a return of 7% for the year but has a TER of 4%, the net gain effectively becomes approximately 3%.
The TER combines all known costs related to operating a particular fund, expressing them as a single number typically represented as a percentage, based on the fund’s assets. Thus, the TER amount depends on the fund’s performance.
Funds generated through the TER cover management, trading, legal fees, audit costs, and general operating expenses. Changes in operating expenses likely reflect adjustments within the TER. Actively managed funds tend to have higher TERs due to increased personnel and transaction-based fees. In contrast, automated or passive funds, with their lower operational costs, result in a lower TER.
Total Expense Ratio (TER) Formula and Calculation
Here’s how to calculate the TER:
To calculate the TER:
- Obtain the total assets of the fund from financial disclosures mandated for mutual funds.
- Derive the total costs from the prospectus, accounting for all operational costs, including trading, management, and marketing expenses.
Understanding Operating Expenses
Operating expenses include any financial obligations tied to the fund’s management and transactions, such as employee compensation, brokerage fees, accountant fees, shareholder communications, financial statements, record-keeping mechanisms, and custodial services.
A portion of the TER may also cover general business operation costs, like space rental and utilities, commonly referred to as overhead expenses.
Differences Between TER and GER
The gross expense ratio (GER) represents the total percentage of a mutual fund’s assets dedicated to running the fund before any fee waivers or reimbursements. New funds often benefit from waived fees to maintain a lower expense ratio for investors initially. Conversely, the TER reflects the fees after reductions through waivers, reimbursements, or recoupments.
Limitations of the Total Expense Ratio (TER)
The TER aims to capture the full cost of owning an investment fund. However, it may exclude one-time charges or fees deduced from investment capital, such as commissions, stockbroker fees, securities transfer tax, and annual advisor fees.
Conclusion
The total expense ratio (TER) is a valuable metric for investors, enabling them to measure and compare the costs associated with the management and operation of investment funds. By understanding the TER, investors can better assess a fund’s efficiency and suitability for their investment portfolio.
Related Terms: Mean Absolute Deviation, Investment Fund, Management Fee, Active Management, Passive Management.
