Expense ratios are one of the easiest investing costs to underestimate because they usually look small in percentage terms. A fund charging 0.75% may not sound dramatically different from one charging 0.10%, and both can seem minor compared with market returns. But over long holding periods, even small annual fee differences can quietly compound against you.
The SEC’s investor education materials explain that mutual fund and ETF fees and expenses reduce your investment returns, and Investor.gov states plainly that a fund with higher costs must perform better than a lower-cost fund just to generate the same result for you. That is the key principle investors often miss: expense ratios are not just a line item. They are an annual drag on compounding.
That matters even more because fees today are already much lower than they used to be, which means investors now have access to many low-cost options if they choose carefully. The Investment Company Institute reported in April 2026 that, in 2025, the average expense ratio for equity mutual funds was 0.40%, for bond mutual funds 0.36%, for index equity ETFs 0.14%, and for index bond ETFs 0.09%. Vanguard also stated in March 2026 that its asset-weighted average expense ratio was 0.06%.
Bottom line
Expense ratios matter because they reduce returns every year, not just once. Over 20 years, the difference between a low-cost fund and a more expensive one can add up to thousands or even tens of thousands of dollars depending on how much you invest, how long you hold, and what your returns would have been before fees. Investor.gov specifically says that higher-cost funds must outperform lower-cost funds just to deliver the same net return, and it points investors to FINRA’s Fund Analyzer to measure the long-term impact of fees.
For most long-term investors, the right lesson is not “always buy the absolute cheapest fund no matter what.” The better lesson is: do not ignore a recurring cost that compounds against you every single year.
Who this article is for
This guide is especially useful if you are:
- comparing ETFs or mutual funds,
- building a long-term portfolio,
- trying to understand whether a higher-fee fund is worth it,
- or investing for retirement in an IRA, 401(k), or taxable brokerage account.
It is also useful if you have heard that fees matter but have never seen clearly why a difference that looks tiny on paper can become meaningful over time. The SEC and Investor.gov both stress that mutual fund and ETF fees are ongoing costs that affect what investors keep.
What an expense ratio actually is
An expense ratio is the percentage of fund assets that goes toward the fund’s operating expenses each year. Investor.gov explains that these expenses can include items such as investment advisory fees, marketing and distribution expenses, brokerage costs, custodial costs, legal fees, accounting costs, and transfer agency expenses. These costs are passed on to shareholders through fees and expenses disclosed in the prospectus fee table.
That means if a fund has an expense ratio of 0.50%, the fund deducts costs equal to half of one percent of assets annually. You usually do not see that as a separate charge leaving your bank account. Instead, it is embedded in the fund’s performance.
That hidden-feeling structure is exactly why many investors fail to pay enough attention to it.
Why small percentages become big over time
The problem with expense ratios is not that they are huge in year one. The problem is that they keep reducing the value that remains invested, which means you lose not only the fee itself but also the future growth that money could have generated.
Investor.gov’s bulletin on fees and expenses says that fees and expenses can affect the value of your investment portfolio and specifically encourages investors to compare these costs over time. FINRA’s Fund Analyzer exists for the same reason: long-term fee drag is not always intuitive until you model it.
A simple way to think about it is this:
- a one-time cost hurts once,
- but an annual percentage cost keeps reducing your compounding base.
That is why a difference of a few tenths of a percent can matter much more than it first appears.
A simple 20-year example
Let’s say you invest $10,000 for 20 years and assume a hypothetical gross annual return of 7% before fund fees.
Scenario A: 0.10% expense ratio
Net return after fee: roughly 6.90%
Scenario B: 0.75% expense ratio
Net return after fee: roughly 6.25%
That gap does not look dramatic in a single year. But over 20 years, the lower-cost fund ends up materially ahead because less money is being lost to annual expenses.
This example is an illustration, not a quote from a regulator. But it reflects the core principle the SEC and Investor.gov emphasize: ongoing fees reduce long-term returns and require higher-cost funds to outperform just to keep pace with lower-cost alternatives.
What current fund fee levels tell us
The good news for investors is that many funds have become cheaper over time.
The Investment Company Institute reported in 2026 that average expense ratios for long-term funds have fallen substantially over the last 29 years. From 1996 to 2025, average expense ratios for equity mutual funds fell 62% and for bond mutual funds 57%. In 2025, average expense ratios were 0.40% for equity mutual funds, 0.36% for bond mutual funds, 0.14% for index equity ETFs, and 0.09% for index bond ETFs.
That is important because it means investors often do not need to accept high fund costs as normal. Today, low-cost broad-market exposure is widely available.
Vanguard also said in March 2026 that its expense-ratio reductions since early 2025 were on track to deliver more than half a billion dollars in savings to investors, and that in 2026 alone it expected nearly $250 million in savings from lower expense ratios.
ETFs vs. mutual funds: are ETFs always cheaper?
Not always, but they often can be.
ICI’s 2025 fee data showed lower average expense ratios for index ETFs than for many mutual fund categories, especially on the passive side. At the same time, Investor.gov explains that both mutual funds and ETFs have fees and expenses, and neither should be treated as automatically cheap without checking the prospectus and fee table.
The practical takeaway is:
- do not assume “ETF” means low-cost,
- do not assume “mutual fund” means expensive,
- and always look at the actual expense ratio.
When a higher expense ratio might still be reasonable
A higher expense ratio is not automatically a deal-breaker. What matters is whether you are getting something valuable enough to justify it.
Examples where a higher-cost fund may still deserve consideration include:
- specialized exposure that is hard to replicate cheaply,
- a strategy not available in broad low-cost index form,
- or a fund playing a very specific role in a portfolio.
But the hurdle is real. Investor.gov states that a higher-cost fund must perform better than a lower-cost one just to deliver the same result to the investor. That means a higher expense ratio should be treated like any other recurring cost: something that must be justified, not ignored.
Where investors often go wrong
1) Looking only at returns, not fees
A fund’s past performance can attract attention, but the SEC and Investor.gov both emphasize that fees are a separate, ongoing force on returns. A strong recent return does not make a high fee irrelevant.
2) Assuming small fees do not matter
That is the core mistake. A fee that looks tiny in one year can become meaningful over 10, 20, or 30 years because of compounding.
3) Ignoring the fee table in the prospectus
Investor.gov explains that these fees and expenses are disclosed in a standardized table near the front of the prospectus. That is where investors should look.
4) Comparing products without a fee tool
Investor.gov specifically points investors to FINRA’s Fund Analyzer to compare fee impact across funds and over time.
5) Focusing on commission-free trading and forgetting fund costs
Zero-commission brokerage access can be useful, but it does not eliminate the internal cost of the fund itself. The fund expense ratio still matters.
How to compare expense ratios more intelligently
A practical way to compare fund costs is to ask:
1) What is the exact expense ratio?
Do not rely on vague labels like “low-cost.” Check the actual number in the prospectus or on the fund page.
2) What am I getting for that cost?
Is this a simple broad-market fund, or something specialized?
3) Is there a lower-cost alternative that does roughly the same job?
If yes, the burden is on the higher-fee fund to justify itself.
4) How long do I expect to hold this?
The longer the holding period, the more fee drag matters.
5) Have I modeled the impact?
Investor.gov and FINRA both encourage using cost comparison tools because long-term fee impact is easier to understand when quantified.
A practical investor mindset
For long-term investors, the goal is not to obsess over every basis point. It is to avoid lazy fee mistakes.
That usually means:
- paying close attention when two funds are similar but one is clearly cheaper,
- not overpaying for basic exposure,
- and remembering that recurring costs reduce the portion of return you actually keep.
In other words, expense ratios are one of the few investment variables you can actually control.
Bottom line
Expense ratios matter because they quietly reduce returns every single year. The SEC and Investor.gov both make this clear, and current 2025–2026 fee data show that low-cost investing is widely available in many parts of the market. The average expense ratio for index equity ETFs in 2025 was 0.14%, while Vanguard said its asset-weighted average expense ratio was 0.06% in 2026.
That does not mean every investor must always buy the absolute cheapest fund. It does mean investors should take annual fund costs seriously, especially when holding investments for 20 years or longer.
A small fee difference can look harmless today and still become expensive tomorrow.
FAQs
What is an expense ratio?
An expense ratio is the annual percentage of a fund’s assets used to cover operating expenses such as advisory, custodial, legal, accounting, and other costs. Investor.gov explains that these costs are passed along to shareholders and disclosed in the fund prospectus.
Why do expense ratios matter so much?
Because they reduce your investment returns every year. Investor.gov says a higher-cost fund must perform better than a lower-cost fund just to generate the same return for you.
What are average fund expense ratios right now?
According to ICI’s 2025 data released in 2026, the average expense ratio was 0.40% for equity mutual funds, 0.36% for bond mutual funds, 0.14% for index equity ETFs, and 0.09% for index bond ETFs.
Are ETFs always cheaper than mutual funds?
Not always. Investor.gov says both ETFs and mutual funds have fees and expenses, so investors should compare the actual expense ratio rather than assuming one structure is always cheaper.
How can I compare fund fees over time?
Investor.gov recommends FINRA’s Fund Analyzer, which helps investors estimate the long-term impact of fees and expenses on mutual funds, ETFs, and ETNs.
Disclaimer
This article is for educational purposes only and should not be treated as individualized investment, tax, or legal advice. Before investing, review the fund prospectus, fee table, and current disclosures carefully, and consider whether the fund’s cost structure fits your goals and time horizon.
Elijah Finn is a Registered Investment Advisor (RIA) and the Principal Analyst for Core Capital Report. With eight years of experience as a Portfolio Analyst at Morgan Stanley Wealth Management, Elijah specializes in translating complex financial strategies into clear, actionable advice for high-net-worth and middle-market clients. He holds an MBA in Finance from the University of Chicago Booth School of Business and maintains his Series 65 certification, adhering to a strict fiduciary standard in all analyses. His work focuses on maximizing long-term wealth through rigorous due diligence on investment vehicles, high-value credit cards, and robust insurance policies.