YW Blogcast 23 - Fear the expense ratio!

You’ve got a handful of prospectus’s from your favorite mutual fund companies, and it’s time to sit down and give them a critical read. As a newbie investor, you don’t want to screw things up from the start. When you get to the part that discusses expense ratios, don’t raise your eyebrow and skip past it. This is a big deal and could radically change your bottom line return in the years and decades to come.

The first thing to know is that all funds have expense ratios. The second thing to know is that they are not all created equal. An expense ratio is a percentage of your portfolio that goes back to the mutual fund every year to cover their (mis)management and administrative fees. When you invest in stock funds, you’re not going to avoid this fee. Sorry. Whether you make or lose money, you pay the fee. That’s why we prefer real estate, though we won’t complain too loudly if you want to dip your toes in an index mutual fund first.

Just keep this in mind. Expense ratios vary from 0.75% to 1.75%. Here are some numbers to put it in perspective. If you invested $5,000 in a fund with a 2% expense ratio for five years and averaged 10% return, you would pay the fund a total of $642 over that time frame. While that’s not a bloodcurdling amount, it’s a chunk – a chunk of your money that you handed over to someone else.

That’s why we like the direct investment model of real estate. Cut out the middleman and keep all the money for yourself. Regardless of how you choose to invest, you now know what an expense ratio is.