Q: I'd like to start a Roth IRA that is invested pretty conservatively, since I have other investments that are more aggressive and growth oriented. I've heard a lot about paying attention to expense ratios and management fees to ensure your money isn't eaten up by high fees. What is an average expense ratio or fee, and do you have any suggestions for finding a Roth to meet my needs? Denise - Elk Grove
A: Using qualified plans are a great way to save for retirement. More importantly, nowadays we are afforded few tax breaks, so utilizing tax efficient vehicles is a great decision. The Roth IRA is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The Roth IRA's principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement. With this description, think of a Roth IRA as more of an investment account than an actual investment.
An expense ratio is a measure of what it costs an investment company to operate a mutual fund. Most often, the expense ratio is determined through an annual calculation, where a fund's operating expenses are divided by the average dollar value of its assets under management (AUM.) Essentially these expenses can be explained as operating expenses represented as a percentage of AUM.
Being aware of the cost of any product you purchase is a smart decision. Investing is no different than purchasing a good filet from your grocer. You wouldn't go to the best grocer in town and assume that if they have high quality meat their prices are fair. Similarly, as a product, not all mutual funds are structured equally. For instance, actively managed mutual funds require higher transaction costs, a larger staff and increased accounting expenses. Mutual funds that focus on the emerging markets require offices overseas which carry expenses such as translation costs, foreign regulatory expenses and the likes.
Think of an expense ratio as a measuring tool when comparing similar apples to each other. When comparing two mutual funds with different performance expectations; an investor would recognize more aggressive funds typically have higher expense ratios.