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In mutual fund investing, it is always advisable to look beyond mere returns and consider the costs associated with it; what is left after deducting that is what you make.It is here that you should take a long hard look the expense ratio .Expense ratio is something which often goes unnoticed but it influences your investment outcomes substantially, making it essential to determine what is a good expense ratio for a mutual fund. Understanding it will help you unlock the true potential of your mutual fund investments.So, what is a good expense ratio ?
What is mutual fund expense ratio?
An expense ratio is the annual fee that AMCs charge to settle a mutual fund’s operational expenses such as administrative costs, management costs, legal costs and marketing expenses.So, technically, it is the calculation of the expenses that come with investing in a mutual fund. This amount is a small percentage of the fund’s overall assets.The expense ratios, including the lowest expense ratio mutual funds are inversely tied to the fund sizes. Larger funds have lower expense ratios as expenses are being met from a huge asset base; it is the other way around for smaller funds.Investors should ideally accord due consideration to expense ratio as it directly affects the returns they receive.Still, mutual funds are a great way to earn a regular income. Learn how now to make the best out of them.
Breaking down the expense ratio
We have already explained what constitutes the expense ratio. Let us consider these components a bit more deeply:
Management fee:
Mutual funds hire skilled professionals as fund managers to ensure the fund functions smoothly and seamlessly. They offer intensive research and formulate the fund strategy, and for that, a fee of 0.5% to 1.0% of the asset base is charged. This is a big part of the fund’s expense ratio.
Maintenance fee:
Apart from management fees, AMCs must bear expenses related to record tracking, customer support etc. This cost is met via maintenance / administrative fees; this too contributes to expense ratio.
Marketing and distribution fee:
AMCs also spend on marketing and promoting of the mutual fund so as to create awareness and increase its Assets Under Management (AUM).The expense is raised as commission for distributing pamphlets, conducting promotional activities and advertisements.
What is exit load?
Apart from expense ratio, there is another expense that can come into play: exit load . This is a fee charged for withdrawing from a fund before a specific period.The fee is charged as a specific bid to discourage investors from withdrawing early, as short-term investments can affect a fund’s performance.SEBI mandates that the exit load has to be credited to the scheme.There is no fixed exit load for the various categories of mutual funds; the amount charged depends on the kind of fund the investment is in, as explained below:
- Equity Funds: Considering the investment value at the time of redemption, typically exit load is charged at 1%.
- Debt Funds: Usually, the exit load is around 3% if the investment is redeemed within a year; 2% if redemption is within two years, and 1% if it is within three years; no exit load is applied beyond that.
- Ultra-Short Term/ Liquid Funds: Often, almost no exit load is charged if the investments are held for three to six months.
Expense ratio calculation
The formula to calculate the expense ratio is quite simple; it is sum of all costs borne by the mutual fund divided by the average assets under managementThe total costs here relate to the expenses incurred by the AMC in terms of fund manager’s fee, marketing and distribution expenses, and legal or audit costs.Average assets under management would be the entire value of all of the investors’ corpus in the fund.You can learn more about calculating the expense ratio of a fund here .The total cost necessary to maintain and operate the mutual fund scheme are sometimes also referred to as Total Expense Ratio (TER) . The TER is a percentage of the scheme’s daily NAV, which is displayed after subtracting the expenses every day.You can learn more about how you can use the NAV of a fund to decide which fund would be the best for you.
Determining high and low expense ratio of mutual funds in India:
If you want to assess if the expense ratio of a particular mutual fund is high or low, you can always compare it with the limits laid down by SEBI and determine what is a good expense ratio for a mutual fund. Also, the TER decreases as the AUM rises. For instance, for equity-oriented mutual funds, the TER is 2.25% for funds with an AUM ranging from 0-Rs 500 crore, and starts falling as the AUM goes up; you can check the table below.For passively managed index funds and ETFs , the expense ratio is 1%. The limits are different for other passive funds.
| AUM Size (in crores) | Expense ratio of equity-oriented scheme (in percentages) | Other schemes, excluding index funds/ETFs and Fund of funds (in percentage) |
| Rs 0-500 | 2.25 | 2 |
| Rs 500-750 | 2.00 | 1.75 |
| Rs 750-2,000 | 1.75 | 1.50 |
| Rs.2,000-5,000 | 1.60 | 1.35 |
| Rs. 5,000-10,000 | 1.50 | 1.25 |
| Rs.10,000-50,000 | For every increase of Rs. 5,000 crores in AUM size, expense ratio reduces by 0.05% | For every increase of Rs. 5,000 crores in AUM size, expense ratio reduces by 0.05% |
| Above Rs. 50,000 | 1.05% | 0.80% |
In comparison to the direct plans, the regular plans of mutual funds charge higher expense ratio.This is because when it comes to regular plans, various intermediaries are involved and the fund houses have to compensate them.In direct plans these intermediaries are not required, resulting in a lower expense ratio.
Should you consider expense ratio while investing in a mutual fund?
If you are looking to invest in mutual funds, expense ratio shouldn't be the only factor you consider, especially when evaluating low expense ratio mutual funds in India. While a lower expense ratio can be favorable, it is important to also ensure that the fund's investment strategy and style align with your goals and investment profile.But an expense ratio does play an important role when it comes to screening your investment options. No matter how small or irrelevant a 2% charge may seem in the short term, it does cause significant implications over time.It is also important to note that the expense ratio has its effects on the returns a fund provides. Learn more about the types of returns mutual funds provide to make an informed decision.If you are stuck choosing between two very similar funds, the expense ratio can become the deciding factor.
Conclusion
Remember to always come to a thoughtful decision: no matter how attractive a lower expense ratio may seem, ensure that the fund is really something that suits your investing style and goals.Note that the expense ratio is deducted automatically from your investments daily, so you don't really have to make separate payments to the AMC.When exploring low expense ratio mutual funds in India , it is important to look beyond just the expense ratio. Look for the balance between the costs of the investments and the potential returns, which heavily depend on the fund performance, risk management and your long-term goals.Immerse in informed-decision making to make the most out of your investment journey.
FAQS - FREQUENTLY ASKED QUESTIONS
Do the returns of mutual funds include the expense ratio ?
No, it does not; the returns are net of expenses i.e., the expense ratio is deducted while calculating the NAV. It represents what the investors have actually earned after the deduction. Higher the expense ratio, lower the returns.
What is a good expense ratio for a mutual fund ?
There is no fixed predetermined percentage that is considered good. You can always draw your own conclusion when comparing these expense ratios, see what makes sense to you and if the costs are worth the returns.
Do every mutual fund charge an expense ratio ?
Yes, all mutual funds do charge and come with expense ratios. The percentage varies across mutual funds and depends on the category you choose.
Is it possible to avoid expense ratios fully ?
No, you cannot, every fund that you invest in will lead to expenses. These expenses are inevitable.
How does a higher expense ratio affect me ?
A lower expense ratio increases the returns you received by the end and vice versa. It can come off as a surprise to certain investors when their returns turn out to be low because of the higher expense ratio.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
