# Expense ratio: what 2% a year costs > An expense ratio, the yearly fund fee, is charged on the whole balance, every year, whatever the return. Over twenty years of 3,000 a month, 2% instead of 0.3% costs 220,130 UAH, about half of the growth. - Course: [Personal Finance: Budget, Safety Cushion, Debt and Investing](https://productovi.com/courses/personal-finance.md) - Module: How to invest without illusions? - Lesson 23/32, ~19 min - Source: https://productovi.com/courses/personal-finance/fees-and-time ## What is an expense ratio? **Alex Tutor:** Dana is still investing with your help, and a consultant has made her an offer. **Dana:** A consultant offered me a fund run by "experienced managers". The fee is 2% a year. The index fund I looked at takes 0.3%. Is 1.7% really worth arguing about? **Alex Tutor:** The **expense ratio** is the share of your money a fund takes every year for running it. It's charged on the whole balance, not on the gain, and it's charged in bad years too. Let's see what that takes. **Alex Tutor:** Assume the fund earns 5% a year above inflation before fees. That's an assumption for the maths, not a promise. Take 100,000: after a year it's 105,000 before the fee. **Sofia:** And the 2% is taken from the 105,000, not from the 5,000 of growth. > **Exercise:** 100,000 UAH grows 5% in a year before fees, to 105,000. The fund then takes its 2% yearly fee from the balance. **How much is the fee?** In UAH. ## Twenty years of 3,000 a month **Dana:** 2,100 out of a 5,000 gain. That's 42% of the year's growth, gone. **Alex Tutor:** Now your actual plan: 36,000 a year, 3,000 a month, put in at the start of each year for twenty years. Same 5% before fees. Three columns: no fee, 0.3% and 2%. **Dataset (CSV):** [36,000 UAH a year for 20 years at three fee levels](https://productovi.com/datasets/personal-finance/fees-and-time/fee-drag-20-years.csv) Assumed 5% a year above inflation before fees, so all amounts are in today's hryvnias. The fee is taken from the balance at the end of each year. An illustration, not a forecast. - `year`: Year 1–20 - `contributed_uah`: Total put in so far, UAH - `no_fee_uah`: Balance at year end with no fee, UAH - `fee_0_3_uah`: Balance with a 0.3% yearly fee, UAH - `fee_2_uah`: Balance with a 2% yearly fee, UAH **Balance at the end of each year, UAH** | Year | Put in | 0.3% fee | 2% fee | | --- | --- | --- | --- | | 1 | 36000 | 37687 | 37044 | | 2 | 72000 | 77139 | 75162 | | 3 | 108000 | 118439 | 114386 | | 4 | 144000 | 161675 | 154747 | | 5 | 180000 | 206936 | 196279 | | 6 | 216000 | 254317 | 239015 | | 7 | 252000 | 303919 | 282990 | | 8 | 288000 | 355844 | 328241 | | 9 | 324000 | 410202 | 374804 | | 10 | 360000 | 467106 | 422717 | | 11 | 396000 | 526677 | 472020 | | 12 | 432000 | 589038 | 522753 | | 13 | 468000 | 654322 | 574957 | | 14 | 504000 | 722663 | 628674 | | 15 | 540000 | 794206 | 683950 | | 16 | 576000 | 869102 | 740828 | | 17 | 612000 | 947506 | 799356 | | 18 | 648000 | 1029583 | 859582 | | 19 | 684000 | 1115505 | 921554 | | 20 | 720000 | 1205453 | 985323 | *Same contributions, same return before fees. After 20 years: 1,205,453 with a 0.3% fee, 985,323 with 2%.* **Sofia:** For ten years the lines stay close. Then they open up like scissors. **Alex Tutor:** Because the fee compounds too: every hryvnia it takes stops growing for all the years that follow. Read the last row and compare the two fees. > **Exercise:** Use year 20 of the dataset. How much **less** does Dana have with the 2% fee than with the 0.3% fee? In UAH. ## A share of the growth, not of the money **Dana:** 220,130 less. That's more than six years of my contributions. **Alex Tutor:** Now measure it against what the money earned. Dana puts in 720,000 in total. With no fee she'd end at 1,249,893, so the growth is 529,893. How much of that growth does the 2% fee take? **Sofia:** Growth lost is the no-fee balance minus the 2% balance, divided by the no-fee growth. **Alex Tutor:** Exactly. Against the whole balance a fee looks tiny; against the growth it shows its real size. > **Exercise:** Dana puts in 720,000 UAH. With no fee she'd have 1,249,893 after 20 years; with a 2% fee, 985,323. What **share of the no-fee growth** does the 2% fee take? In %, two decimals. ## The fee is certain, the return isn't **Dana:** Half the growth. But maybe the experienced managers earn more than 5%, and the fee pays for itself? **Alex Tutor:** Maybe. But the fee is certain and the extra return isn't, and many actively managed funds end up behind their index once fees are paid. A higher fee doesn't buy a higher return; it only guarantees a higher cost. **Alex Tutor:** And try a weak twenty years: 2% a year above inflation before fees. With a 0.3% fee Dana ends at 862,917. With 2%, at 716,984, less than the 720,000 she put in. **Sofia:** So in a bad market the fee can eat all of the real growth. > **Exercise:** **True or false:** in a weak market, a 2% yearly fee can leave an investor with less than they put in, even though the fund earned something before fees. ## Every cost on one list **Dana:** Is the yearly fee the only cost I should look at? **Alex Tutor:** The biggest over decades, but not the only one. There can be a fee for entering the fund, a broker's commission on each purchase, the exchange spread when hryvnias become dollars or euros, and tax on the gain when you sell. **Alex Tutor:** Write them all down before the first purchase. You can't control the market's return. Costs are one of the few things you do control. **Sofia:** Last year's return isn't a cost, though. The consultant led with that. > **Exercise:** Which of these are **costs** Dana should list before her first purchase? Select all that apply. ## Your turn: answer the consultant **Dana:** He'll call back on Monday. I want to answer with numbers, politely, and not get talked round. **Alex Tutor:** Three or four sentences: what 2% costs over twenty years in hryvnias, what share of the growth that is, and what the fund would have to prove to be worth it. **Sofia:** And a question back: what are all the other fees? **Dana:** Good. Questions are easier to say than no. > **Exercise:** Write Dana's reply to the consultant (3–4 sentences): what the 2% fee costs over 20 years compared with 0.3%, what share of the growth that is, what the fund would have to prove, and one question about other costs. > **Key ideas** > > - The **expense ratio** is taken from the whole balance every year, in good and bad years: 2% of 105,000 is 2,100, or 42% of a 5,000 gain. > - Fees compound: 36,000 a year for 20 years at an assumed 5% before fees ends at **1,205,453** with a 0.3% fee and **985,323** with 2%: 220,130 less. > - Measured against growth, 2% takes **49.93%** of what the money earned; 0.3% takes 8.39%. > - In a weak market (2% before fees), a 2% fee leaves 716,984, less than the 720,000 put in. The fee is certain; any extra return isn't. > - List every cost before buying: yearly fee, entry fee, broker's commission, exchange spread, tax on gains. This is educational, not personal financial advice. **Alex Tutor:** Next, the module's case: Leo's "just buy crypto", a too-good offer in a messenger, and a plan that survives a bad year. - Previous lesson: [Diversification and index funds](https://productovi.com/courses/personal-finance/diversification-and-index-funds.md) - Next lesson: [Case: "just buy crypto" vs a regular plan](https://productovi.com/courses/personal-finance/hot-tip-case.md) --- Productovi Learning. Free, no sign-up needed to read.