The expense ratio of a stock or asset fund is the total percentage of fund assets used for administrative, management, advertising (12b-1), and all other expenses. An expense ratio of 1% per annum means that each year 1% of the fund's total assets will be used to cover expenses. The expense ratio does not include sales loads or brokerage commissions.
Expense ratios are important to consider when choosing a fund, as they can significantly affect returns. Factors influencing the expense ratio include the size of the fund (small funds often have higher ratios as they spread expenses among a smaller number of investors), sales charges, and the management style of the fund. A typical annual expense ratio for a U.S. domestic stock fund is about 1%, although some passively managed funds (such as index funds) have significantly lower ratios.
One notable component of the expense ratio of U.S. funds is the "12b-1 fee", which represents expenses used for advertising and promotion of the fund. 12b-1 fees are generally limited to a maximum of 1.00% per year (.75% distribution and .25% shareholder servicing) under Financial Industry Regulatory Authority Rules.
The term "expense ratio" is also a key measure of performance for a nonprofit organization. The term is sometimes used in other contexts as well.