Bogle (1999b) concluded 92% of return shortfall for active managers was due to expenses. Expense ratio shows the percentage of fund assets annually spent for overhead (i.e., shareholder services, rent, administrative salaries, etc.) and management. The expense ratio does not include trading costs or reflect any bid-ask spread and does not include any sales commissions or purchase or redemption fees. According to Zweig (1997b), management (advisory) fees represent 60%+ of the total expense ratio. Expense ratios range from < 1/10th of 1% (0.1) to > 3%; the typical yearly charge is ~ 1.0%.
The biggest beneficiary of economies of scale is the fund, not its shareholders (investors). Bogle (1998) noted fund assets increased by 6,650% over a 17-year period studied, yet expenses increased by 8,470% and “in periods of normal returns, a 2.5% expense ratio consumes 50% of investor net ‘real’ returns.”
Zweig (1997) discovered 56% of all bond and stock funds with 10-year records had increased their expense ratio. Another study shows a 38% increase in expense ratios from 1986 to 1999. Moreover, one fund had a net profit of $62 million on $95 million of expenses, a 66% profit margin. Bogle (1994) found fund expenses represented 54% of stock fund income, 12% for bonds, and 18% for money market funds.
Since most funds do not outperform their benchmark index, performance incentive fees are common; Zweig (1999a) found just 2% of U.S. stock funds had incentive-based management fees. Some funds decrease management and other fees based on break points. For example, Vanguard waives a $20 annual charge for accounts with a balance of < $10,000; the fee is also waived if the investor signs up for e-delivery of statements and other information.
A handful of Vanguard funds also charge a fee of 0.25% to 1.00% when shares are bought or sold; the fee discourages trading, which is expected to benefit long-term buy-and-hold investors. Vanguard does not have any marketing or distribution costs, also known as 12-b-1 fees. According to Lipper, the industry average expense ratio is 1.0% vs. 0.2% for the typical Vanguard fund (as of 12/31/2014). The Vanguard 500 Index Fund (VFINX) has a 0.17% expense ratio with a minimum $3,000 initial investment and just 0.05% for accounts valued at $10,000+. As of July 2015, Vanguard, a well-known advocate of indexing, was the third largest active equity fund company in the world (Morningstar, 2015).