Investing
How To Calculate ETF Costs
An expense ratio looks tiny and is not. It is charged every year, so it compounds against the portfolio in exactly the way the return compounds for it.
Quick Answer
net return = gross return - expense ratio; value = investment x (1 + net)^years
- V
- Portfolio value without fees
- r_g
- Gross annual return the fund earns
- r_e
- Expense ratio charged each year
- r_n
- Net return, equal to gross return minus expense ratio
£10,000 for ten years at an 8% gross return is £21,589 without fees. With a 0.20% expense ratio the net return is 7.8% and the fund is worth £21,193, so the fee has cost £396. A 0.05% fund instead reaches £21,490.
What Is ETF Costs?
An exchange-traded fund charges an ongoing fee called an expense ratio, quoted as a percentage of assets and taken every year. A 0.20% ratio costs £20 a year on £10,000, which sounds small until it compounds.
The fee is not taken as a visible charge. It is deducted from the fund's assets before the price is struck, so the investor never sees a line item and only notices that the return was slightly lower than the market.
The computational difficulty is that the return is known gross and the fee is charged on the balance. So the net return is not gross return times a constant factor; it is gross return minus the ratio, and then the whole net figure compounds.
Compounding annually is correct here. An expense ratio is an annual charge on an annual return, so the horizon is measured in years and the exponent is the number of years. A monthly contribution is a different calculation with a different exponent.
The drag grows superlinearly with the horizon. Doubling the years more than doubles the cash cost, because the fee is charged on a balance that has itself grown, which means later years cost more in absolute terms than earlier ones.
As a share of the fee-free outcome the drag is far larger than the ratio suggests. Over ten years a 0.20% ratio removes 1.8% of the fee-free value, and over thirty years the same ratio removes roughly 6%.
The expense ratio is the largest predictable cost but not the only one. Trading costs, bid-ask spreads, securities lending revenue and taxes all shift the outcome, and none of them appear in the headline ratio.
Funds with higher turnover and narrower holdings tend to charge more, because running them costs more. A broad market index fund should be cheap and an actively managed specialist fund is allowed not to be.
The ratio is charged on assets under management, not on performance. A fund that loses money still charges its ratio, so a bad year costs the fee and the loss.
Securities lending revenue can offset part of the cost. A fund that lends holdings to short sellers receives fees and passes a share back, which is why some funds quote a net expense ratio below the gross one.
Comparing two funds only needs the difference in ratios. A 0.20% and a 0.05% fund differ by 0.15% a year, and that difference, compounded over a long horizon, is the entire case for choosing the cheaper one.
The difference is worth more the longer the horizon, which is exactly the wrong shape for a fee that is invisible in the first year. Most of the cost of an expensive fund is paid in years nobody plans for.
The decision is only about predictability. Nobody can know whether an expensive fund will outperform; the fee is the one part of the outcome known in advance, so minimising it is the only move that is certain to help.
The calculator compounds the investment at the net return, repeats the exercise for a cheaper comparator fund, and reports the value drag of the fee and the difference between the two funds.
Formula
net return = gross return - expense ratio
The ongoing charge is expressed as a percentage of assets, so it is subtracted directly from the annual return. Both figures are per year and use the same base.
| Symbol | Meaning | Unit | Notes |
|---|---|---|---|
| r_g | Gross return | percent | Annual return before fees. |
| r_e | Expense ratio | percent | Ongoing charge as a share of assets. |
| r_n | Net return | percent | Annual return after the charge. |
V = P x (1 + r_n)^n + A x ((1 + r_n)^n - 1) / r_n
The lump sum compounds at the net return, and each annual contribution compounds for the years remaining. This is an ordinary annuity in years, not months.
| Symbol | Meaning | Unit | Notes |
|---|---|---|---|
| P | Initial investment | currency | Amount invested at the start. |
| r_n | Net return | percent | Gross return minus expense ratio. |
| n | Years | years | The investment horizon. |
| A | Annual contribution | currency | Amount added at the end of each year. |
| V | Final value | currency | The portfolio at the end of the horizon. |
drag = fee-free value - actual value
Compounding the same contributions at the gross return gives what the portfolio would have been worth with no fee at all. The difference is the entire cost of the charge.
| Symbol | Meaning | Unit | Notes |
|---|---|---|---|
| V_g | Fee-free value | currency | Value at the gross return. |
| V_n | Actual value | currency | Value at the net return. |
| D | Value drag | currency | What the expense ratio has cost. |
How To Calculate ETF Costs
- 1
Subtract the expense ratio from the gross return
An 8% gross return with a 0.20% ratio compounds at 7.8%. Subtracting is correct because the ratio is quoted per year on the same base as the return.
- 2
Choose the horizon
Years, not months. The exponent is the number of years and every extra year compounds both the return and the fee against the whole balance.
- 3
Compound the initial investment
Raise one plus the net return to the number of years and multiply by the amount invested at the start.
- 4
Add each annual contribution
Each contribution compounds for the years after it is made, which makes the stream an ordinary annuity measured in years.
- 5
Repeat at the gross return to find the drag
The gap between the fee-free value and the actual value is the cost of the charge, and it is far larger than the ratio times the years.
Examples
Example 1: £10,000 for ten years at 8% with a 0.20% fee
- Investment
- £10,000
- Gross return
- 8%
- Expense ratio
- 0.20%
- Cheaper fund ratio
- 0.05%
- Years
- 10
- Annual contribution
- £0
| Step | Calculation | Result |
|---|---|---|
| Net return | 8% - 0.20% | 7.80% |
| Fee-free value | £10,000 x 1.08^10 | 21589.25 |
| Value at the net return | £10,000 x 1.078^10 | 21192.76 |
| Value drag of the fee | £21,589.25 - £21,192.76 | 396.49 |
| Cheaper 0.05% fund | £10,000 x 1.0795^10 | 21489.51 |
| Saving from the cheaper fund | £21,489.51 - £21,192.76 | 296.74 |
Result: The 0.20% fee lowers the net return to 7.80% and leaves the fund at £21,192.76 against a fee-free £21,589.25, a drag of £396.49. The 0.05% fund reaches £21,489.51, so the 0.15% difference is worth £296.74 over the ten years.
Example 2: £50,000 over twenty years at 9% with a 0.75% fee
- Investment
- £50,000
- Gross return
- 9%
- Expense ratio
- 0.75%
- Cheaper fund ratio
- 0.10%
- Years
- 20
- Annual contribution
- £2,000
| Step | Calculation | Result |
|---|---|---|
| Net return | 9% - 0.75% | 8.25% |
| Total contributed | £50,000 + £2,000 x 20 | 90000 |
| Value at the net return | £50,000 x 1.0825^20 + £2,000 x 47.05 | 338175.98 |
| Fee-free value | £50,000 x 1.09^20 + £2,000 x 51.16 | 382540.78 |
| Value drag of the fee | £382,540.78 - £338,175.98 | 44364.80 |
| Cheaper 0.10% fund | £50,000 x 1.089^20 + £2,000 x 50.59 | 376302.52 |
Result: With a 0.75% ratio the net return is 8.25% and £90,000 of contributions reaches £338,175.98. The fee-free figure is £382,540.78, so the fee has cost £44,364.80, and a 0.10% fund would instead reach £376,302.52, recovering £38,126.54 of it.
Calculator
Net annual return
7.80%
- Fund value
- $21,192.76
- Cost of the expense ratio
- $396.49
- Cheaper fund value
- $21,489.51
- Saving from the cheaper fund
- $296.74
- Value with no fee at all
- $21,589.25
- Drag as a share of fee-free value
- 1.84%
Values update as you type. This calculator covers the single scenario its formula assumes — see Common Mistakes for what it leaves out.
Prefer a full-width tool? Open the ETF Costs calculator page.
Common Mistakes
Multiplying the return by one minus the fee
A 0.20% ratio does not remove 0.20% of the return; it removes 0.20 percentage points from it. On an 8% return that is the difference between compounding at 7.84% and compounding at 7.80%.
Compounding monthly when the ratio is annual
The ratio is an annual charge on an annual return, so the exponent is the number of years. Monthly compounding belongs to monthly contributions, not to an annual fee.
Quoting the fee as a percentage of the return
The ratio is a percentage of assets. A 0.20% fee on a portfolio returning 8% is 2.5% of that year's return, not 0.2% of it.
Ignoring the horizon
The drag compounds, so the same 0.20% ratio costs about 1.8% of the fee-free value over ten years and roughly 6% over thirty. Short-horizon comparisons make expensive funds look free.
Forgetting that the fee is charged on losses too
The ratio is deducted whether the fund rises or falls. A bad year costs the fee as well as the loss, so the fee does not shrink when performance does.
Comparing only the headline ratio
Trading costs, spread and taxes also move the outcome. Two funds with identical ratios can differ in total cost by more than the ratio itself suggests.
Assuming a cheaper fund always wins
Minimising the fee is the only certain improvement. Whether a more expensive fund earns back its charge is unknowable in advance, so the fee is a floor on cost rather than a prediction of return.
FAQ
What is a good ETF expense ratio?
For a broad market index fund, below 0.10% is normal and below 0.05% is achievable. Specialist, active or narrowly held funds charge more because they cost more to run, and a higher ratio needs a stronger case.
How much does a 0.20% expense ratio cost?
Over ten years at an 8% gross return it costs about 1.8% of the fee-free portfolio value. The cash figure grows faster than the horizon because the fee compounds on a balance that is itself growing.
Is the expense ratio taken from my return or from my balance?
From the balance, which is why it looks like a slightly lower return. The fund deducts it from assets before the price is set, so there is no separate charge to see.
How should I compare two funds?
Subtract one ratio from the other, compound the difference over your horizon, and multiply by the contributions. That single number is the entire financial case for choosing the cheaper fund.
Does the fee matter for a short horizon?
Less, but it is still a certain cost. A ten-year horizon turns a 0.20% ratio into 1.8% of the fee-free value, and a thirty-year horizon turns the same ratio into roughly 6%.
Are expense ratios negotiable?
Not directly, because they are set by the fund and deducted automatically. The way to lower them is to choose a different fund, which is why the ratio is worth checking before buying.
References
- [1]U.S. Securities and Exchange Commission, Expense ratios and fund fees — https://www.investor.gov/introduction-investing/investing-basics/glossary/mutual-fund-fees-and-expenses
- [2]Financial Industry Regulatory Authority, ETFs and fees — https://www.finra.org/investors/learn-to-invest/types-investments/etfs
- [3]U.S. Securities and Exchange Commission, Fund fees and expenses — https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds