Total Expense Ratio - TER

Ooooh, kind of a hotly debated issue, and a hot topic with Warren Buffett and the index fund vs. hedge fund worlds. Why? Well, first, what it is:

A given fund has $400 million under management. It's an index fund pegged to tech smallcap growth companies. It owns about 200 of them, and makes a few small adjustments each year as a few are bought, a few get too big for the index, and a few go bankrupt or get delisted. That fund has total operating expenses to the investor of 0.5%, or $2 million.

Then there's an actively managed mutual fund in the same arena. It tries to invest more smartly than that index, and pays a dozen analysts and a few portfolio managers to oversee the fund. That mutual fund charges 1%, or $4 million a year.

Then there's a hedge fund that charges "two and twenty," i.e. 2% management fee and 20% of profits.

So, in a given year, when all was hot in tech and that fund was up 30% (the index was up that much), the index fund would have delivered a "net" up 29.5% to investors. The mutual fund (if it was average, like most mutual funds) would have delivered 28% in performance, and then 1% less for the fees, or 27%, net performance. That hedge fund, were it also up that much, would have delivered 30% gross, but then take away 2% in fees and 20% of the remaining 28% upside, or another 5.6% in fees, to give to the investors a net 22.4% (7.6% subtracted from 30%) performance.

Terrible. Huge fees. Crappy performance. Welcome to the debate of TER, which revolves around the question: why would anyone do anything other than just buy index funds and call it a day? Good question.