In this episode, we break down two fundamental concepts essential for evaluating investment performance and efficiency. First, we examine the expense ratio, defined as the percentage of a fund’s total assets used to cover administrative, management, and advertising costs. We discuss why this metric is crucial for investors, detailing how a 1% expense ratio can consume a significant portion of historical gross returns depending on the investment type. We also explore why it is difficult for funds to lower these ratios after their first few years of operation due to the nature of fixed and variable expenses.

The second half of the episode focuses on the Sharpe ratio, a tool developed by Nobel laureate William F. Sharpe to measure risk-adjusted returns. We explain how this "reward-to-variability" ratio calculates the excess return an investor receives per unit of risk. Listeners will learn how to interpret this data to rank fund managers and why reliance on the Sharpe ratio requires caution—particularly regarding strategies that smooth returns or assets with non-normal distributions.