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Suppose a mutual fund invests only in other mutual funds, instead of investing in stocks or bonds directly. Does the reported expense ratio of that fund include the expense ratios of the funds it holds, or is it an expense over and above those of the funds it holds?

For example, consider the Vanguard Target Retirement 2045 Fund (VTIVX), which invests solely in three other funds:

  • Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) - 63.4%
  • Vanguard Total International Stock Index Fund Investor Shares (VGTSX) - 26.4%
  • Vanguard Total Bond Market II Index Fund Investor Shares (VTBIX) - 10.2%

VTIVX has an expense ratio of .19%. But the three funds it invests in also have their own expense ratios: .18%, .22%, and .12%, respectively. If I invested in those three funds directly, in the same proportion as VTIVX does, my investment would have an effective expense ratio of .18% x 63.4% + .22% x 26.4% + .12% x 10.2% = .18%.

So, does that mean an investment in VTIVX effectively loses .19% + .18% = .37% per year in expenses overall, or does VTIVX's expense ratio of .19% include the .18% expense ratio of its holdings, plus .01% to cover its own costs?

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2 Answers 2

up vote 8 down vote accepted

From The Prospectus for VTIVX;

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as compared to the Total Stock Market Fund;

enter image description here

You can see how the Target date fund is a 'pass through' type of expense. It's not an adder. That's how I read this.

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My understanding is that normally Fund of Funds have their own expense fees that is over and above the expenses charged by the respective fund. I am not sure about VTIVX. –  Dheer Jun 28 '12 at 3:15
    
Agreed, but here, those zeros say otherwise. –  JoeTaxpayer Jun 28 '12 at 3:20
2  
+1 Funds-of-funds usually have a small amount of added-on expense fee; if it is more than 0.1% you are paying far too much. One advantage of using funds-of-funds instead of investing directly in the same proportions in the individual funds is that re-balancing to maintain the same proportions will not result in (possibly taxable) realized gains and losses if you are in a fund-of-funds. –  Dilip Sarwate Jun 28 '12 at 11:44
    
Investopedia says "Acquired Fund Fees and Expenses" accounts for the expense ratios of the fund's holdings, and is required to be included in the reported expense ratio of the fund-of-funds. investopedia.com/terms/a/acquiredfundfeesandexpenses.asp –  Paul Kuliniewicz Jun 28 '12 at 21:15
    
@PaulKuliniewicz - I think you are confirming the accuracy of my response. It's a passthrough, and first three lines showing "none" mean no additional fees. –  JoeTaxpayer Jun 28 '12 at 21:44

I just looked at a fund for my client, the fund is T Rowe Price Retirement 2015 (TRRGX). As stated in the prospectus, it has an annual expense ratio of 0.63%. In the fine print below the funds expenses, it says "While the fund itself charges no management fee, it will indirectly bear its pro-rata share of the expenses of the underlying T. Rowe Price funds in which it invests (acquired funds). The acquired funds are expected to bear the operating expenses of the fund." One of it's acquired funds is TROSX which has an expense ratio of 0.86%. So the total cost of the fund is the weighted average of the "acquired funds" expense ratio's plus the listed expense ratio of the fund. You can see this at http://doc.morningstar.com/docdetail.aspx?clientid=schwab&key=84b36f1bf3830e07&cusip=74149P796 and its all listed in "Fees and Expenses of the Fund"

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