What is Expense Ratio in Mutual Fund?

Introduction

Mutual funds are one of the most sought-after investment vehicles for those who want to increase their asset in a long time. Investors neglect a very important aspect that directly affects their returns - expenses ratio. The expense ratio is the cost of managing and running the mutual funds and is taken out of the investor's returns.

Knowledge of mutual fund expense ratio is important for appropriate investment. In this article, a detailed description of the expense ratio, impact on returns, calculations, regulatory boundaries, and fees by SEBI will be explained.

What is an Expense Ratio in Mutual Funds?

The expense ratio is an annual fee levied by mutual funds to pay for operating costs such as fund management, administrative expenses, marketing, and other overheads.

Expense Ratio Meaning

Simply put, the cost ratio is the cost of running and managing mutual funds. The lower the expense ratio, the lower the cost for the investor, resulting in more net returns. It is an important factor to keep in mind when selecting mutual funds, as small changes in expense ratio can bring a big difference in prolonged investment growth.

Components of the Expense Ratio

There are many components in expense ratio, each contributes to the total cost:

1. Fund Management Fee : Fee paid to fund managers for management and investment decisions of portfolio.

2. Costs related to fund operation including administrative expense-rid-keeping, accounting and customer service.

3. 12B-1 Fee : The expenses spent to promote marketing and distribution of funds is known as 12B-1 fee.

4. Custodian and Audit Fee : Fee to protect funds and operate periodic audit.

5. Regulatory and Legal Fee : Costs related to compliance, legal formalities and regulatory filing.

The Formula to Calculate the Expense Ratio

The Expense Ratio is a key metric used to measure the cost of managing an investment fund relative to its assets. It is expressed as a percentage and calculated using the following formula:

Expense Ratio = (Total Expenses/ Total Assets Under Management (AUM)) × 100

Breakdown in Table Format

Example Calculation:

If a mutual fund has total expenses of ₹10 crore and an AUM of ₹5000 crore, the expense ratio would be:

Expense Ratio=(105000)×100=0.20%

This means the fund charges 0.20% of its assets annually to cover its expenses.

How to calculate expense ratio in mutual funds

For example, if a mutual fund, a total annual expense of 1 crore is spent and asset under the Management of 100 Crore (AUM), then there will be an expense ratio:

This means that investors will pay 1% of their invested amount annually to cover fund expenses. If an investor has an investor invested ₹ 10 lakh in this fund, then it will cost 10,000 per year.

SEBI Expense Ratio Limit

The Securities and Exchange Board of India (SEBI) has set limitations at the maximum expense ratio that can charge mutual funds. There are limitations:

SEBI has introduced these boundaries to ensure that investors have not been overcharged and transparency in mutual fund expenses have been promoted.

When is the expense ratio charged?

The expense ratio is not charged separately from an investor; Instead, it is cut off from the returns of mutual funds. The net asset value (NAV) of the fund has already been adjusted to expenses, which means that the returns displayed by the fund are post-expense cuts.

For example, if a fund earns 12% in a year and its expense ratio is 1.5%, then the investor will be 10.5% after effective returns.

Effect of expense ratio on returns

A high expense ratio reduces the overall return of an investor. Consider the following example:

• Fund A: 12% Return annually with an expense ratio of 2%

• Fund B: 11% Return annually with an expense ratio of 0.5%

For an investor who invests ₹1,00,000 in both funds:

As seen in the table, despite a slightly lower withdrawal rate, Fund B with lower expense ratio produces much long -term returns.

How to find Mutual Funds with Low Expense Ratio?

Finding Mutual Funds with low expense ratio is important to maximize investment returns. Here's how you can do it:

1. Use Mutual Fund Screeners : Websites such as Morningstar, Value Research and Moneycontrol allow the fund to be filtered based on the expense ratio.

2. Compare fund categories : Index funds and ETFs usually have lower expense ratios than actively managed funds.

3. For direct schemes, see : Direct schemes of mutual funds have lower expense ratio than regular plans.

4. Analyze Aum and Fund Performance : Large funds often cost less due to scale economies, but check if the low cost is align with good performance.

What is a good expense ratio?

A good expense ratio varies depending on the type of fund:

• Index funds and ETF - 0.1% to 0.5% are considered good.

• Actively managed equity fund - 1% to 2% is acceptable; Anything above 2.5% is more.

• Debt Fund - 0.5% to 1.5% is appropriate.

• Hybrid fund - 1% to 2% is specific.

Conclusion

Expense ratio is an important factor that affects mutual fund returns. Investors should analyze carefully whether the fees charged by a fund are appropriate based on its performance and investment strategy. Choosing a fund with a proper expense ratio can help maximize returns in a long time.

By monitoring the expense ratio and understanding their impact, investors can take clever investment decisions that align with their financial goals.

You may also read Top 10 Benefits of Investing in Mutual Funds