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Expense Ratio in Mutual Funds

Expense ratio, as the name suggests, is the percentage of expenditure incurred towards the management of a particular fund/scheme in mutual fund. These mutual fund schemes are introduced in the market by AMCs (Asset Management Companies). Information about expense ratios is widely available through their portals and is worth keeping an eye on.

The expense ratios are important to understand for buyers of mutual funds. For example, in September 2018, the RBI outlined detailed guidelines about reducing the TER or Total Expense Ratio of mutual funds. As a rule of thumb, if the total investment portfolio of the AMC is small, you are likely to incur higher charges.

On the other hand, as an individual buyer, it might be in your interest to invest in a small fund. This is where your investment has the power to influence the AMC’s credibility and reputation. Hence, expense ratios can play a significant role in understanding the risks and potential of an investment.

Components of Expense Ratio

Usually, expense ratios are fixed. Expense ratio is usually divided into three main charges: the management fees, administrative costs, and the distribution fees. These costs are presented and explained to investors every six months. So, if you are worried about its potential to eat into your investments, you might want to find ways to attend this meet.

Management Fees

Conventionally, mutual funds are usually known for their experts who vouch their reputation on the line for your investment. Many buyers go out of their way to invest with big and credible names. On the other hand, professional AMCs invest heavily in experience and educational practice to manage funds. This is essential for mutual fund operators to invest in a sound and robust investment strategy to guarantee your success. The management fee is largely pocketed by the management who makes crucial decision regarding your investments. This fee varies from 0.5% to 1% on an average.

Administrative Costs

Administrative costs for mutual funds include customer support, service, and other day-to-day operating costs. These can vary greatly from a mutual fund firm to another. The administrative costs can also prove to be difficult to adjudge as an outsider. However, company cultures provide a peek into understanding the real worth of administrative costs. A small company culture which values transparency and accountability can be ideal for keeping administrative costs to a minimum. On the other hand, a large company delivering high returns can make administrative costs seem like a trivial matter to consider.

Distribution Fees

Distribution fees are aimed at reaching consumers with promotional campaigns. These are charged to shareholders and potential investors alike to promote the fund to new buyers. The management fees, distribution fees, and administrative costs form the major portion of expense ratio in mutual funds.

Expense Ratio Impact on Fund Returns

As mentioned earlier, it is important to understand the expense ratio before investing in a mutual fund. If your AMC charges are 2% to manage your fund, and your earnings are 15%, you will be gaining a Net Asset Value (NAV) of 13%. You need to watch out for the TER figure too before accepting a mutual fund proposal. On an investment of Rs. 20,000, a 2% TER may only equal to 4%, but it provides a peek into how a fund is managed. For example, a fund with a large influx of investors is likely to register lower funding expenditure as compared to a fund which needs to invest heavily in distribution costs. As the size of the funds increases, administrative costs per buyer are also likely to decrease.

Mutual Fund Expense Ratio Calculation

It is important to keep some pointers in mind if expense ratios really concern you. Depending on the type of mutual fund you invest in – the expense ratio can vary significantly. For example, investing in an index fund can be significantly cheaper than investing in FoF or a Fund of Funds. Index fund management takes into account the index of markets like Nifty 50. It shuns the requirement to look at the performance of a stock, but considers their relative weight to measure their potential value. This requires significantly lesser management and hence, results in significantly lower expense ratios.

Exchange-Traded Funds

Exchange-Traded Funds or ETFs passively invest in bonds, stocks, and commodities. These are flexible investment options for fund managers and require a simple Demat account for buyers. General investments in stock markets can be made directly by buyers. As ETFs do not incur significant day-to-day investment by AMCs, these manifest lower expense ratios as compared to mutual funds.

Fund of Funds

FoFs are investments into other mutual funds. These investments often target mutual funds abroad and require bypassing foreign investors. Additionally, these can also in turn make investments into foreign stocks as an extension. A scheme like Reliance Gold Savings Fund is a good example of these. The expense ratio for these is, on average, a lot higher as compared to regular mutual funds.

If you have set your mind on investing in mutual funds, consider investing in a direct plan mutual fund scheme for lower expenditures. These plans do not require your fund house to pay brokerage to a third-party and hence, your investment remains unaffected by the additional expenditure.

Check out the chart below for a small comparison of various schemes in the market.

Name of Mutual FundType of Mutual FundExpense Ratio
Edelweiss Tax AdvantageELSS2.68%
Axis Long-term EquityELSS2.68%
Reliance Small CapSmall Cap2%
SBI Small and Mid-capSmall and Mid-Cap2.28%
HDFC Growth DirectLarge Cap1.61%

How to Find Expense Ratio of Mutual Fund

If you are searching for something similar to the popular EMI calculator for expense ratio, you are unlikely to find it. Also, you might not need one either. All fund houses publish their expense ratios regularly. These are an important part of their fact sheet. Additionally, professional fund houses also update these facts on a monthly basis through their websites.

Regulations on Expense Ratio by SEBI

There can be a variation in how different companies guide you, particularly with respect to expense ratio. However, SEBI has set guidelines on the general framework of these calculations. Check out the chart below to understand these in detail.

Asset Under Management (crores)TER for equity-oriented schemes (%)TER for other schemes excluding Index Funds, ETFs and Fund of Funds (%)
Rs. 0-5002.252.00
Rs. 500-7502.001.75
Rs. 750-2,0001.751.50
Rs. 2,000-5,0001.601.35
Rs. 5,000-10,0001.501.25
Rs. 10,000-50,000For every increase of 5,000 crore in AUM TER reduces by 0.05%For every increase of 5,000 crore in AUM TER reduces by 0.05%
> Rs. 50,0001.050.80

FAQs on Expense Ratio in Mutual Funds

How is the expense ratio calculated for a mutual fund?

The expense ratio is an aggregation of per-unit costs of operating a mutual fund. These costs are calculated by dividing the total expenditure by the value of assets in question. SEBI has set guidelines for controlling the ceiling of expense ratios. For equity mutual funds, fund houses or AMCs cannot charge more than 2.5% of weekly net assets.

Does mutual fund performance include expense ratio?

Expense ratio information is regularly updated for shareholders and customers alike. It is the percentage of net assets. A percentage of 1.1 means you, as a buyer of the mutual fund, will pay Rs. 11 per thousand rupee purchase. The expenditure is calculated to meet daily operating expenses.

What is a good expense ratio for a mutual fund?

Expense ratios can provide a peek into how efficient and in-demand a mutual fund is. Generally, a good mutual fund rate is considered around 0.5% to 0.75%. This can seem significantly higher, but this is the benchmark for an actively managed fund. Anything above 1.5% is considered a bit too high by most regular investors.

How is the expense ratio charged?

AMCs have the liberty to allocate costs as they like to their fees and general operational expenses. However, these costs then are calculated as a percentage of the weekly net asset value. The daily updates that you will receive from your AMC will deduct the costs of expense ratio before putting out the final number.

Does mutual fund performance include expense ratio?

The expense ratios are deducted from the net gain of investors in advance. Usually, this means the management fees, distribution fees, and administrative costs are calculated in advance. These costs are eventually deducted before submitting the final performance factsheet.

How expenses are deducted from a mutual fund?

Expense ratio is calculated by dividing operating expenses like distribution costs by the average rupee value of its asset under management (AUM). The other costs in expense ratio include management fees and administrative costs.