When compared to stock funds, a bond fund purchase primarily rests on the distribution yield. If you have the choice of two bond mutual funds with similar portfolio characteristics, you will probably choose the fund with the higher yield. The expense ratio of a bond fund directly relates to the yield, and investors should also view expense ratios when comparing different funds.
Mutual Fund Expenses
The costs of running and managing a mutual fund come out of the fund's assets. Expenses include portfolio management, marketing expenses and administrative costs. The amount of expenses a fund company charges investors is reported as an annual percentage of the assets in the fund; it's called the expense ratio. Find a fund's expense ratio in the prospectus or online listed as the total annual operating expenses. This number is the fund's expense ratio.
Average Bond Fund Expenses
According to the "2012 Investment Company Fact Book," in 2011 the median expense ratio for bond funds was 0.90 percent. The median is where half the funds have higher expenses and half lower. The asset-weighted average expense was 0.62 percent. This lower than median number indicates that more money is invested in funds with lower expense ratios. The "Fact Book" data show that 80 percent of bond funds fall into an expenses range of 0.50 to 1.69 percent per year.
Expense Ratio Effects
Since bond fund expenses come out of a fund's assets, the expense ratio can be viewed as a direct reduction of a funds yield. The management company will take the expense costs from the interest coming into the fund before passing the remainder on to investors as fund dividends. Consider a bond fund that earns an average of 6 percent interest from its portfolio. If the fund's expense ratio is 1.5 percent, the net yield paid to investors will be 4.5 percent. If the fund's expense ratio is 0.5 percent, the fund will yield 5.5 percent. The result is a full 1 percent difference just from the lower expense ratio.
Comparing Bond Funds
The expense ratio should be just one of several factors used to analyze prospective bond fund investments. Other factors to evaluate include types of bonds -- government, municipal or corporate -- credit quality of bonds and the average term to maturity of a fund's portfolio. Selecting a bond fund with a more conservative investment approach and lower expenses may pay off better in the long run than a fund that takes investment risks to cover for a high expense ratio.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.