One of the big advertising kicks today from mutual funds is to tell how low their expense ratio is and that you will make a great deal more money if you buy and hold with them. Partly true, but that is not the whole story.

What is the expense ratio? It is all their overhead including but not limited to all the managers and other employees salaries, rent, computers, utilities, travel (the fund manager says he has to visit a company in Florida in the winter to see how it is doing), advisory services, telephone, etc., etc, etc. Oops, and dont forget the managers bonus whether he makes money for you or not. If the fund has one billion (yes, thats a B) that means they can spend $10,000,000 on expenses and no one will complain because it is a tiny 1%.

At some point expenses just about stop going up as you dont need very many more people to manage the paper work for a billion than you do for 250 million. The fund managers duties remain the same just the size of the orders he places changes. Actually as a fund grows in size its expenses should automatically come down as a percent of assets, but you will find that is not the case for many funds. They keep sticking it to their investors who dont have any idea how egregious this is.

The larger the fund family the lower should be their expenses per fund as they can outsource from the fund to a central billing and customer service desk.

Vanguard Funds has more than 100 individual funds in its family and they brag on how low is their expense ratio. It should be as they have more than 720 Billion spread out over those funds. They keep their expenses low and at only 1/2% they can charge about 360 million to offset their overhead.

Many funds run very high expenses. This is especially true for new and smaller funds, but as they take in more money they can spread their expenses and lower their ratios. One of the recent criticisms of funds is they have been making extra charges labeled 12B-1 that are supposed to be expressly for promotion to bring in new customers. Unfortunately, some (not all) of the fund managers have been pocketing this. If this does bring in new money then the expense ratio should fall and again in many cases it has not.

Investors expect fund managers to be honest. When large sums of money are at stake it seems to bring out the worst. That real nice fund manager turns into a hungry wolf and the investor becomes one of the 3 little pigs that did not escape.