In this video, we will be talking about the expense ratio of mutual funds.

In this video, we will be talking about the expense ratio of mutual funds. There are many costs associated with the sale and purchase of mutual funds. Out of these costs, an important cost we should keep in mind is the expense ratio. As we all know, a mutual fund is managed by a team of people, which includes fund managers, analysts and sales teams. The entire set up has to incur various costs to attract investors and to operate the mutual fund in the best way possible.

These costs make up the expense ratio, also known as the TER or total expense ratio. It is charged from all investors as a percentage of their total investment. For example, if you invest ₹10,000 in a mutual fund and its expense ratio is 1%, you will have to pay ₹100 for the management of your fund.

Now, let us discuss the three major components of an expense ratio.

The first is the management expenses. These include the compensation to the fund managers who are responsible for the success of the mutual fund.

Next, we have the administrative expenses. These include the basic expenses which assist the day-to-day operations like customer support, communications, etc.

Lastly, we will talk about the 12 B1 distribution fees.

Asset Management Companies collect these fees from their shareholders to promote their funds to potential investors. Now, let’s address a very important question – how does the expense ratio affect our investment return?

The Net Asset Value or NAV of the fund is calculated on a daily basis after the deduction of the expense ratio. So, we can conclude that the expense ratio will affect our profitability on a daily basis. If our investment return is 10%, and the expense ratio is 1%, our total return will come to 9%. Therefore, the higher the ratio, the lower our profitability will be, and vice versa.

Now, let us understand how mutual funds in India charge us this ratio.

The markets regulator SEBI has fixed limits on the expense ratios.

The limits on the total TER are:

2.5% on the first ₹100 crores of the average weekly total net assets;

2.25% for the next ₹300 crores;

2% for the next ₹300 crores; and

1.75% for the remaining net assets.

The expense ratio limit for all debt funds is 2.25%.

As an informed investor, you should always check the expense ratio. Even though it is just a small percentage value of the total assets, it is one of the few factors that directly affect our return percentage.