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What You Need to Know
On your exam you could be expected to identify the investment objectives of mutual funds bsed solely on the expense ratios provided in the test question. In this post and video taken directly from our video training classes, we will show you how to answer these questions correctly.
The mutual fund expense ratio comprises all the expenses passed through to the investor. Effectively, the mutual fund expense ratio tells the investor how much it costs them to have the mutual fund company manage their money.
What Makes Up the Expense Ratio?
You have the board of directors, they get paid. You have an investment advisor. That is the biggest expense of the mutual fund company. They certainly get paid. Their fee is always a percentage of the net asset value. The custodian bank safeguards the portfolio for the mutual fund and they are paid for that service. The transfer agent handles name changes, issues, and redeemed shares, and they are paid for that service as well.
Example: Comparing Mutual Fund Expense Ratios
Here we have an example of 4 different fund companies with 4 different expense ratios:
- Fund A with an expense ratio of .15%
- Fund B with an expense ratio of .45%
- Fund C with an expense ratio of .75%
- Fund D with an expense ratio of 1.3%
The test could ask you which one of these is the growth fund. The one with the highest expense ratio is going to be the growth fund because they have to pay the investment advisor more to meet a more aggressive objective.
It is much harder to achieve a growth objective than it is to perhaps achieve an income objective.
So here in our example, fund D would be the growth company.
+Series 7 Note: Growth funds and expense ratios are commonly paired in Series 7 exam questions that test your understanding of fund objectives vs. costs.
Expense Ratios and Fund Objectives
They could also ask you which one is the money market fund. The expense ratio on money market funds is extremely low. It will be the lowest one in your answer key.
And here in our example, it would be fund company A.
Fund company B might be an index fund, one designed to track the results of the S&P 500 or the NASDAQ Composite. They tend to have lower expense ratios because they’re not doing active asset selection. They are merely buying shares of securities that are represented in that particular index. It is a passive investment strategy. Fund company C with an expense ratio of .75 may be that income fund. Perhaps this is a corporate bond fund.
SIE and Series 6 Reminder: Knowing the relationship between fund type and expense ratio is key for answering suitability and fund comparison questions on the exam.
Summary: Mutual Fund Expense Ratios on the Exam
This is a great example of some of the concepts you could be tested on as it relates to a mutual fund expense ratio.
Understanding these expense components alongside fund objectives is critical for passing the SIE, Series 6, and Series 7 exams.
