Assessing Mutual Fund Expenses and Transaction Costs

Abstract

This is a first-step mutual funds study that provides analysis and disclosure of the elements of a newly defined total expense ratio, which includes the regulatory expense ratio, brokerage commissions, and implicit trading costs. Three structures are provided that identify whether a particular fund’s total expense ratio is relatively reasonable or excessive relative to each of two benchmark funds. The concepts of expense effectiveness and breakeven rate of return are employed in this process.

Mutual fund brokerage commissions and implicit trading costs vary significantly among various types and styles of domestic equity funds, and when summed they are not infrequently larger than a fund’s regulatory expense ratio. This is true in the current study for Vanguard 500 Index Fund. The continuing bad news is that disclosure of brokerage commissions and implicit trading costs remains effectively hidden and completely hidden, respectively, from fund shareholders. This must change and this study provides an approach for doing so.

Keywords: mutual fund, total expense ratio, expense effectiveness, breakeven rate of return, brokerage commissions, implicit trading costs, S&P 500 index fund

JEL Classification: G2, G23, G28