By now, it’s no secret that the costs charged by investment funds are critically important. In fact, when choosing among funds in the same category, they’re the single most important differentiator. In the words of Morningstar, the investment research firm, “If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios [i.e., the cost of a fund] help you make a better decision.”

But how exactly do you go about totaling up an investment’s costs? And should you sell an expensive investment even when that sale might incur taxes? Below is the approach I recommend:

Step 1: The first step is to track down each fund’s expense ratio, sometimes referred to as its management fee. You can find those on each fund company’s website. You can also find them on websites like Yahoo Finance or Barchart.

Note: When you’re looking up a fund’s expense ratio, be sure to look it up by ticker symbol rather than by name. That will ensure that you are looking at the right “share class” of the fund since different share classes usually carry different fees.

To put the expense ratio in dollar terms, simply multiply that percentage by the dollar value of your holding in each fund. For example, if you have $10,000 invested in a fund that carries a 1% fee, the expenses are $100 per year.

Step 2: If you hold a fund in a taxable (non-retirement) account, you’ll want to quantify its tax impact. This information is often overlooked because it’s harder to find, but this is a perfect time of year to start looking. In the coming weeks, as you receive 1099 tax forms for each of your investments, look for the line that reads “capital gains distributions.”

Note: There is an important distinction between capital gains on the sale of a fund itself—which are your choice and entirely voluntary—and capital gains generated by trading inside a fund—which are at the discretion of the fund manager and not your choice at all. It is the latter type of capital gains—the “distributions”— that you want to examine. That’s because, as a shareholder in a fund, you are responsible for your pro rata share of taxes on capital gains generated by the fund.

To determine the tax impact of these distributions takes a little work, but in general, you want to do the following calculations:

• Multiply the fund’s long-term capital gains distributions by your capital gains tax rate. Your capital gains rate will depend on your overall income level and whether you’re married or single, so you may wish to consult your accountant for help.
• Multiply short-term capital gains distributions by your marginal tax rate—that is, the rate that applies to your regular income.
• If your state levies an income tax, do these same calculations with your state tax rates.

Step 3: Total up the above expenses and taxes. Continuing with the above example, if your fund’s expenses are $100 per year, and the taxes on capital gains distributions are $200, then the fund is costing you a total of $300 per year.

Step 4: To put these numbers in context, divide your total costs into the value of your fund holding. In this case, $300 divided by $10,000 equals 3%. To judge that figure, I would use these rules of thumb:

• Total fees and taxes of less than 0.20%: Excellent
• Between 0.20% and 0.40%: Good
• Between 0.40% and 1.0%: Fair
• More than 1.0%: Unacceptable

Step 5: In the above example, we calculated a total cost of 3% per year, which puts it squarely in the unacceptable category. If any of your holdings fall into this category, you have a few choices:

• You could donate it to charity.
• You could sell it in a year when you have an offsetting loss on another investment.
• If you are near retirement, you could hold onto it until a time when your tax rate is lower.
• You could give it to one of your adult children, whose capital gains tax rate might be lower (or even zero).
• You could sell it. If this is the option you want to pursue, continue on to the next step.

Step 6: Suppose you’ve determined that a fund is overpriced, and you want to sell it. But if the fund isn’t in a retirement account, then the sale might trigger a tax. How do you know if the sale would be worthwhile? I recommend this simple calculation:

• Determine the tax you’d incur if you sold it. (You may wish to consult your CPA for this step as well.)
• Divide that tax by the total annual cost of holding the fund (from Step 3, above).

This calculation will tell you how many years it would take you to break even on the sale. For example, if the estimated tax were $1,000, and your annual cost of holding the fund is $300, then it would take you about three years to break even. If it were me, I would do this trade. But if the breakeven point were longer—say 10 or 20 years—then I wouldn’t be as quick to sell. Instead, you might opt to hold onto it until you were ready to pursue one of the other options outlined in Step 5, above.

A few caveats:

First, you’ll notice that in these calculations, I’m looking at the absolute cost of an investment and not comparing it to the cost of any alternative. This might seem like an unfair comparison, except that there are many investments today which are so low-cost and so highly tax-efficient that they are virtually free. So I do think that zero is an appropriate benchmark for comparison.

Second, I acknowledge that high expenses may be justified by a narrow slice of funds, but those outliers are mostly in private equity, venture capital and sometimes hedge funds. What I’m referring to here are ordinary mutual funds, where high costs generally do not correlate with better results.