Learn how “Expense Ratio” impacts your Mutual Fund Returns

EXPENSE RATIO

I hope you have gone through the blogs on basic understanding about mutual funds. Then let me jump in on some topics, which are not so interesting but if not taken care of, have a good impact on your returns.

WHAT DO YOU MEAN BY EXPENSE RATIO?

Well! Everything in this world needs to be managed by someone and Mutual Funds are no exception to that. So the cost incurred to run the mutual fund business and the operating expenses incurred to give you the maximum return possible is termed as Mutual Fund Expense.
So Expense Ratio is a ratio of measuring the expenses incurred as compared to the asset portfolio being managed. So simply if the lower the total assets under management, higher will be the expense ratio.

GIVE ME AN EXAMPLE PLEASEūüôŹ

Suppose you have invested in a mutual fund, which has a corpus of 1 cr and the mutual fund charges charged from you are 15,000 rupees. So the Expense Ratio would be
15,000/1,00,00,000*100 = 0.15%
Since most of the expense ratio is in terms of day-to-day operating expenses, the larger the Assets under Management, the lower the ratio would be.

So taking above example, if the total assets under management were 2 cr instead of 1 cr, then the expense ratio would dip to 0.075%.

BUT WHAT EXPENSES DO MUTUAL FUND INCURS?

The expenses of mutual fund companies composed of many categories, but the top ones are :-

  • Management Fees:-¬†Behind every successful fund manager, the most important reason is their fund manager. Fund Manager is none other than the person who formulate investment strategies based on stock market ups and downs and tries to maintain the mutual fund returns at maximum. For this the Fund manager should be educationally and professionally sound with Expert knowledge of the market. Nothing comes for free in this world and so the fund manager too. Their handsome remuneration keep them motivated (mostly in Cr.), and that ranges usually as 0.5%-1.0% of total mutual fund portfolio.
  • Admin Fees:-¬†To maintain a large size portfolio, certain administrative charges are incurred. These costs are fixed costs like book-keeping, customer service, advertisements etc. They depend on the size of the fund.
  • Distribution Fees:-¬†This is charged from the shareholders to promote their mutual funds in the market.

So all in all, above 3 combined constitutes the Expense Ratio, the most prominent one is Management fees. However, the fund buying selling of securities are not included in the calculation of expense ratio.

Point to note that Redemption fees, is not part of the Expense Ratio and charged separately from the fund investors.

HOW CAN I SEE THE EXPENSE RATIO OF A MUTUAL FUND?

Above Expenses charged by the fund are reflected(adjusted) in Daily Net Assets Value (NAV). You will not be able to find a separate Expense Ratio being charged. The expense ratio is published on a half-yearly basis.

WHAT IF MUTUAL FUND COMPANIES CHARGE ME A HIGHER EXPENSE RATIO?

Well the good news is that recently SEBI has put a limit on the expense ratio. Calculated on its average net assets, the current ceiling is:-

  • Equity Fund – Not more than 2.5%;
  • Debt Fund – Not more than 2.25%
  • Index Fund – Not more than 1.5%
  • Fund of Funds – Not more than 0.75%

OK! SO THIS IS A SERIOUS TOPIC! HOW I AM IMPACTED IN LONG TERM

Refer the below table, on how you will be impacted with expense ratio. I have highlighted the loss(reduction in returns) you might incur if you compare expense ratio of 0% with 2.5%.

 

Expense Ratio
Expense Ratio Impact

Ok, now I hope you that your concepts towards Expense Ratio and its impact on Mutual fund returns are clear now. So next time you invest in Mutual Fund, just confirm the exit & entry load along with Expense Ratio %.

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Author: AK

Ankit is a part-time blogger with full-time employment in an investment bank. He is a CA with interest in personal finance topics.

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