What is Expense Ratio in Mutual Fund?

 

 

Expense Ratio of Mutual Fund is one aspect which affects the returns or final amount of a Mutual Fund to a great extent.Mutual Fund companies run a business and to maintain it they incur many expenses, like agent or distributor commission, fund management fees, registrar fees, advertisement and promotional expenses and buying of office properties, salaries and other expenses related to the running of the business.For managing all these expenses, they charge the investors a fees which is finally reflected as Expense Ratio.

Who Pays For the Expenses?

Well, who else but you and me, meaning investors. when you buy the units of the Mutual Fund, the NAVof the Mutual Fund is calculated after deducting the expenses.

Is there any limit on the expenses?

The Mutual Fund can not have an Expense Ratio for their scheme as per their whims and fancies. SEBI has mandated a fixed amount for Expense Ratio. It is a maximum of 2.5% for equity mutual funds and 2.25% for debt Mutual Funds. They may have lesser amount than this but they can not cross it( its should be noted that in its recent circular, SEBI has allowed Mutual Funds to charge an extra 15 to 50 Paise for encouraging investment from tier and 2 cities and some other conditions).

Does Mutual Fund Expense Ratio affects the Returns?

In short term you may not see much of a difference but when you invest for longer duration, for times like 15 to 20 years , it effects the returns significantly. lets take an example for a longer term. if you invest Rupees 01 Lakhs for a duration of 30 years and lets assume the return to be a moderate 12%, then the final amount will be 2995992/- if there was no expense involved and would be 1634267/- if the Expense Ratio was 2%. Wow, a difference of almost 13 Lakhs . That is a substantial amount. to give another example, lets take diversifies large cap equity fund. IDBI India Top 100 Equity Fund has, at the time of writing this article, an Expense Ratio of 2.98% while that of Quantum Long Term Equity Fund has 1.43. here we have taken Regular Plans of both the Mutual Funds for comparison.

How does Mutual Fund Expense Ratio affect me as an investor and what should i do?

First thing you may do is to think of getting yourselves updated on financial knowledge { that is precisely what we are trying to help you with 🙂 } and think of buying Mutual Funds yourselves, to invest in the direct plans and take benefit of lower Expense Ratio. Should your buying decision be purely based on Expense Ratio? certainly not, but it is one of the important parameter. In upcoming posts, we will delve more on this. There are many well managed well performing Mutual Funds which have comparatively higher Expense Ratio but have many other things going for them.

Conclusion

Expense Ratio is a very important parameter that an investor should keep in mind before making any decision, but it should be not evaluated in isolation but used with other parameters.