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Why Should You Care About the Expense Ratio of Mutual Funds?​

Cost is often secondary when something is worth it. International trips are fun and existing, so it might not be a problem if you spend a bit extra out of your pocket. The same logic can be applied to mutual fund investments. If a mutual fund fits your risk appetite and looks promising, you may ignore the costs it carries.

Still, you must draw the line somewhere, and the expense ratio can help you do that. The expense ratio affects your mutual fund portfolio daily, so it deserves attention. This article will give you an end-to-end insight into the expense ratio and what it means for your mutual fund portfolio.

What is the Total expense ratio in mutual funds?

Mutual Funds are permitted to charge certain operating expenses for managing a mutual fund scheme – such as sales & advertising expenses, administrative expenses, investment management fees etc. All such costs for running and managing a mutual fund scheme are collectively referred to as ‘Total Expense Ratio’ (TER). The daily NAV of a mutual fund is disclosed after deducting the expenses.

How is the Total expense ratio calculated?

The Total expense ratio of mutual funds is expressed as follows:

Expense ratio = Total expenses / Average Net Asset Value (NAV)

The operating expenses are incurred regularly. Therefore, actively-managed funds have a higher total expense ratio than passively managed funds because they require regular tracking. However, it cannot exceed a certain threshold as per the norms issued by the Securities and Exchange Board of India (SEBI). The total expense ratio is a function of AUM and the type of mutual fund. Here is how it is calculated:

TypeMaximum Total Expense Ratio (TER)
Close-ended and Interval Equity-oriented funds1.25%
Close ended & Interval Debt oriented schemes1.00%
ETFs, Index1.00%
FoFs investing primarily in Index and ETF schemes*1.00%
FoFs investing primarily in active Equity oriented schemes*2.25%
FoFs investing primarily in active Debt oriented schemes*2.00%

* including weighted average of the total expense ratio levied by the underlying scheme

The expense ratio: why should you care?

Since the expense ratio is deducted from your investment value, a higher expense ratio may lead to lower returns. Therefore, you must check the expense ratio of a mutual fund, along with other factors, before investing in it.

However, that does not mean funds with a lower expense ratio are better than those with a higher ratio. You can evaluate a fund’s expense ratio and invest in it only if it meets your goals, investment horizon, and risk appetite.

Checklist for investing in mutual funds

Knowing the total expense ratio (TER) is vital, but you must also keep a few other things in mind before investing in a mutual fund. We have listed some of them below:

●  Higher AUM doesn’t mean better performance

Although a mutual fund with a higher AUM may be more popular and may have a lower total expense ratio (TER), it does not guarantee returns. The performance of a mutual fund depends only on the performance of the underlying securities.

●  The fund manager’s credentials matter

The total expense ratio (TER) in mutual funds and your risk appetite are vital, but few factors matter as much as fund managers’ credentials. They are responsible for managing and tracking the performance of the assets held by the funds.

●  Is the portfolio mix suitable for you?

Mutual funds invest in equity and debt instruments. Every fund's portfolio mix is available online, so you must analyse the portfolio carefully to assert whether the existing mix fits your profile and analysis.

Mutual fund investments are not as challenging if you do your homework, follow a process, and stay committed to your goals. Knowing the expense ratio is a vital part of your study as it gives you an idea of your expected expenses. Once you are comfortable with a fund’s expense ratio and the fund also meets your goals and risk appetite, you can begin investing in it and march towards your mutual fund investment goals.

Generic Disclaimer
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.

Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.

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