Do you know about Expense Ratio...?

All of us know that now mutual fund investment is totally free from entry load. It means if we invest Rs 10,000 in any mutual fund scheme, the entire Rs 10,000 amount invested in mutual fund’s scheme. For retail investor it is very encouraging thing as earlier there was heavy fee in the name of entry load. After removing entry load we often assume now there are not any fee except exit load if we exit from the scheme within one year. There are a price for every product and a charge for every service. You always pay for what you get, one way or another.
In mutual fund investment, we should not judge it only one parameter like entry fee. We should also check various parameters, such as its past performance with respect to its benchmark and category average, its asset allocation pattern and the fund manager's history and its expense ratio.

The Expense Ratio is also known as Annual Recurring Expenses. It includes the fund management fee, agent commission, registrar fees and the selling and promotion expenses. Other than these charges, a fee is also paid to the custodian, who buys and sells securities in large volumes. A fund’s expense ratio states how much you pay a fund in percentage terms to manage your money.

A mutual fund recovers such costs through its unit holders on a daily basis. The daily net asset values (NAVs) of a fund scheme are reported after deducting such expenses, though the expense ratio is disclosed only once every six months. The market regulator, Sebi, has set a ceiling for the expense ratio. For an equity mutual fund, it cannot be more than 2.5% of its average weekly net assets. For debt funds, the ceiling is 2.25%, while for index funds and fund of funds (FoFs), the expense ratios are capped at 1.5% and 0.75%, respectively.


Many investor do not pay much attention on expense ratio but it is important to know how much it impact to our portfolio return.For example, if you invest Rs 1,00,000 in a fund with an expense ratio of 2.0 per cent. This means that you pay the fund Rs 2000 to manage your money. The expense ratio affects the returns you get as well. If the fund generates returns of 10 per cent, what you will get is just 8.0 per cent after the 2.0 per cent per annum, Different funds have different expense ratios. However to keep things in check, the Securities & Exchange Board of India (SEBI) has stipulated an upper limit that a fund can charge. The limit stands at 2.50 per cent for equity funds and 2.25 per cent for debt funds.

In the below table we can see clearly the impact of expense ratio.

Expense Ratio	5  Year	10 Year	15 Year
0%	1,76234	3,10,585	5,47,357
0.5%	1,71,872	2,95,400	5,07,711
1.0%	1,67,597	2,80,887	4,70,759
1.5%	1,63,407	2,67,019	4,36,329
2.0%	1,59,302	2,53,770	4,04,261
2.5%	1,55,279	2,41,116	3,74,403

In the above table, where the value of Rs 1 lakh is growing at 12% a year. In 15 years, the fund with a 2.5% expense ratio has reduced the value of investments to 20%, compared with a fund that has a 1% expense ratio. If you compare this with an imaginary fund that has no expense ratio, the fund with a 2.5% recurring expense ratio will see an erosion in value of the investment to 32%. This clearly indicates that a high expense ratio can eat into your returns, so you must take into account this factor while investing in a mutual fund.


The impact of expense ratio is greater in case of debt funds, which earn 8-9% on an average. For an investor of an equity fund, paying 2% from an average return of 15-20% may not pinch, but it will hurt to pay 2% in case of an 8-9% average return for debt funds.


There are one more important thing that the expense ratio is charged even when the fund’s returns are negative. Overall, before you invest in a mutual fund, it is important factor that you check out the fund’s expense ratio. But remember that a low expense ratio doesn’t necessarily mean that the fund is good. A good fund is one that delivers good returns with minimal expenses.

Regards,

Arvind Trivedi

Certified Financial Planner
arvind.trivedi79@gmail.com