Index funds are complex, with many factors contributing to the overall performance. One of those factors is the cost levied for the management of the fund, also called the expense ratio. And, the lowest expense ratio index funds will result in fewer dollars leaving your pocket, which means it’s almost always a better deal for you!
This post was written by our staff writer, Lindsey Smith.
Lowest Expense Ratio Index Funds – What Are They?
Fund companies want complete transparency on their fees for investors, and so you can usually find solid breakdowns on the respective websites for every fund you might want to invest in.
But what exactly does it mean?
And which index funds have the lowest expense ratios?
These are the questions we’ll answer below, to help you make the most informed decisions about where to invest your hard-earned money so that you don’t lose any of it to fund expenses.
What is an Expense Ratio?
So what really is an expense ratio anyway?
An expense ratio is the maintenance fee that a mutual fund charges to cover its expenses.
Included in the fee is the annual operating costs like..
- management fees,
- allocation charges,
- and advertising costs of the funds.
Some funds, like mutual funds, require more hands-on management than ETFs or index funds, and thus have a higher expense ratio.
The value of an expense ratio is directly tied to the size of the index fund. If a fund has a smaller pool of financial resources, it will have to give a certain percentage to good management. This increases the expenses in relation to the total funds available.
When you look at larger funds, the amount set aside to cover expenses is smaller in relation to the total asset value.
To find a rough estimate of your expense ratio, you can divide the total expenses by the total assets of the fund. So, the higher the asset base, the lower the ratio, and vice-versa.
- Management fees – this pays the people responsible for the operation of the fund, like portfolio and fund managers. On average, 0.5-1% of the total asset base is paid as management fees.
- Maintenance expenses – this is the cost of paying those who ensure everything runs smoothly and perform any administrative tasks. Things like maintaining investor records, entry and exit fees of the assets in the portfolio, and customer support.
- 12B-1 fee – these are the costs of promoting the fund
- Entry and Exit load – the amount charged to an investor for joining a fund and leaving a fund respectively. The entry is typically low and the exit higher, to encourage people to join and discourage people from leaving.
- Brokerage fees – mutual funds can be either direct or regular. In a regular fund, an asset management company will hire a broker for all the transactions to be processed. Direct funds process them by themselves. So if you’re investing in a regular plan, you will have brokerage fees added into your expense ratio, whereas a direct plan will not have this charge.
The expense ratio information of any index or mutual fund is available on their website, with full transparency, which allows you to make the most informed decision about your investment.
And, more importantly, it helps you find the lowest expense ratio index funds with ease! Because who wants to pay more than they have to??
How Does My Expense Ratio Impact My Return?
In most cases, expense ratios are deducted from the total revenue a fund makes before returns are paid to investors.
A higher expense ratio will mean that a larger portion of the revenue is paid to managing the fund, with less being given to investors.
The expenses of a fund can make a huge difference in overall profit for individual investors.
Let’s say a fund has an annual return of 5%, but their expense ratio is 2%, that means 40% of the returns are going to fees.
- A higher expense ratio also does NOT always mean better management of an index fund.
- It does not mean the fund is performing better or will perform better in the future than other funds.
As with all investments, there are no guarantees. It can mean the fund managers are more aggressive and yield higher returns, which help offset the higher fees. But you can also find lower expense ratio index funds that are run by well trained managers that have consistent, quality yields.
This is why it’s important to read about the expense ratio of any fund you want to invest in prior to putting any money in.
What is Considered a Good Expense Ratio?
The expectation for what is considered a good expense ratio varies between the two main types of funds:
- active, and
What is a good expense ratio for actively managed mutual funds?
Actively managed funds require more hands-on work, and so charge higher fees. These funds require more expertise, and managers are required to perform a massive amount of research and analysis to maximize the performance of the fund.
A good expense ratio for an actively managed portfolio is around 0.5% to 0.75%. Anything above 1.5% is considered high.
What is a good expense ratio for index funds and ETFs?
On the other hand, passively managed funds, such as an index fund that tracks the market or an ETF, requires far less work.
A good expense ratio for an index fund is around 0.2%, but they can be as low as 0.02% or even less.
Which Index Funds Have the Lowest Expense Ratio?
Of all the types of funds to invest in, index funds have the lowest expense ratios overall. Because they’re following a market index, they only have to be changed if the index changes. Think of them as set-it-and-forget-it investments.
The best index funds are typically the ones that follow the S&P 500. They follow the 500 top-performing companies in the United States across every industry, which makes it a generally low risk high reward investment.
The lowest expense ratio index funds with the best returns are:
1) Fidelity ZERO Large Cap Index (FNILX)
Expense Ratio: 0%. For every $10,000 invested, it would cost $0 per year.
This doesn’t officially track the S&P 500, it tracks the Fidelity U.S. Large Cap Index, but it’s essentially the same. It also keeps costs lower because Fidelity doesn’t have to pay the licensing fee for using the S&P name.
2) Schwab S&P 500 Index Fund (SWPPX)
Expense Ratio: 0.02%. For every $10,000 invested, it would cost $2 per year.
This mutual fund has a strong record going back to 1997, and is sponsored by one of the most respected names in the industry.
3) Vanguard S&P 500 ETF (VOO)
Expense Ratio: 0.03%. For every $10,000 invested, it would cost $3 per year.
VOO is one of the largest ETFs on the market, with hundreds of billions in the fund. It’s part of one of the biggest investment platforms out there. And the expense ratios are typically low across the board here, since those who invest with Vanguard also own Vanguard.
Expense Ratio: 0.03%. For every $10,000 invested, it would cost $3 per year.
This is another long established fund, starting in 2000, that tracks the S&P 500. It’s sponsored by BlackRock, one of the largest fund companies. This fund is one of the largest ETFs with a thin expense ratio.
5) SPDR S&P 500 ETF Trust (SPY)
Expense Ratio: 0.09%. For every $10,000 invested, it would cost $9 per year.
The original ETF, starting up in 1993, and one of the most popular. It tracks the S&P 500 and is sponsored by State Street Global Advisors, another big gun in the industry.
It’s got a slightly higher expense ratio than the other four, but it has a solid track record and wrote the book on ETFs.
Lowest Expense Ratio Index Funds – The Key Takeaways
You’re smart to be looking at Index Funds first of all, since their track record is so solid and since there’s built-in diversification. But secondly, they’re often a good pick because of the super low expense ratios!
Other key takeaways regarding the lowest expense ratio index funds:
- Expense ratios are the collection of fees that a fund charges for management and administrative needs.
- An expense ratio has a significant impact on an investor’s returns, and should be carefully researched to ensure the best return.
- Actively and passively managed funds have different expectations for a good expense ratio:
- actively managed funds from 0.5-0.75%,
- and passively managed funds 0.2%.
- Index funds that follow the S&P 500 typically have the lowest expense ratios and good returns.
So what’s your plan? Are you going to pull the trigger on a low expense ratio index fund? Which one will you choose?
AUTHOR Derek Sall
Derek has a Bachelor's degree in Finance and a Master's in Business. As a finance manager in the corporate world, he regularly identified and solved problems at the C-suite level. Today, Derek isn't interested in helping big companies. Instead, he's helping individuals win financially--one email, one article, one person at a time.