A good expense ratio for mutual funds and ETFs depends on the fund type, investment strategy, and available alternatives. Generally, lower expense ratios are better as they allow more of your investment returns to compound over time. Here’s a framework for evaluating expense ratios by fund category:
Index funds (passive):
- Excellent: 0.00-0.10%
- Good: 0.11-0.20%
- Average: 0.21-0.30%
- Above average: 0.31-0.50%
- Expensive: Above 0.50%
Actively managed funds:
- Excellent: 0.50-0.65%
- Good: 0.66-0.85%
- Average: 0.86-1.00%
- Above average: 1.01-1.25%
- Expensive: Above 1.25%
Bond funds:
- Excellent: 0.00-0.20%
- Good: 0.21-0.40%
- Average: 0.41-0.60%
- Expensive: Above 0.60%
Specialty/Sector funds:
- Excellent: 0.30-0.50%
- Good: 0.51-0.75%
- Average: 0.76-1.00%
- Expensive: Above 1.00%
International/Emerging markets funds:
- Excellent: 0.10-0.30%
- Good: 0.31-0.50%
- Average: 0.51-0.75%
- Expensive: Above 0.75%
The importance of expense ratios becomes clear when you consider their long-term impact. For example, on a $100,000 investment earning 7% annually over 30 years:
- With a 0.10% expense ratio, you’d pay approximately $11,000 in fees and have about $750,000
- With a 1.00% expense ratio, you’d pay approximately $95,000 in fees and have about $575,000
That’s a difference of $175,000 in ending value due solely to expenses.
When evaluating expense ratios, consider these additional factors:
- Performance versus benchmark: For active funds, consistently beating their benchmark by more than the expense ratio difference might justify higher fees
- Additional services: Some funds offer financial planning or other services that may justify slightly higher expenses
- Tax efficiency: ETFs are typically more tax-efficient than mutual funds with similar expense ratios
- Trading costs: Some brokerages charge commissions for ETFs but not for their proprietary mutual funds
The industry trend continues toward lower expense ratios, with many major brokerages offering index funds and ETFs with expenses under 0.10%. Given this competitive environment, there’s rarely a good reason to pay high expenses unless a fund offers truly exceptional performance or unique exposure that can’t be found elsewhere.