The expense ratio is the percentage of assets deducted by a fund manager from the accounts of its clients to pay for fees. These fees include the management fee, recordkeeping charges, audit fees, legal expenses, custodial fees, and related charges. Brokerage costs are not included in this calculation. The ratio is used to compare the fee structures of the various funds. Investors use this information to decide which funds are the most affordable. Thus, unless a fund can prove an unusually high performance level, a high expense ratio will tend to drive a reduction in invested money, towards funds that offer a lower expense ratio.
The characteristics of a fund can influence its reported expense ratio. For example, a fund with a smaller amount under management tends to have a large expense ratio, since its fixed costs cannot be spread over a large amount of invested funds. Also, an index fund tends to have a lower expense ratio, since it is engaged in automatic investment activities and so does not need a research staff.