What is expense ratio in mutual funds

Let’s know the meaning of total expense ratio and what is expense ratio in mutual funds. The meaning of TER (Total Expense Ratio) is the amount charged by any company based on its operating expenses it incurs for giving a smooth service to its customers.

The expense ratio applicable to mutual funds in India is governed under the SEBI Mutual Funds Regulations, 1996 and this allows the AMC (Asset Management Company) to charge some percentage of expense ratio to cover its service cost such as sales and marketing expenses, brokerage charges, management expenses, transaction costs and other operating charges for the better functioning of the Demat account and tradings. All these costs summated together are referred to as the total expense ratio.

The particular mutual fund scheme’s average NAV (Net Asset Value) will decide the percentage of TER to be charged from the traders. It will directly affect the scheme’s NAV which means that the higher the total expense ratio, the lower the NAV of a scheme and vice versa. Every day NAV is decided only after subtracting the TER. Therefore, it is an important factor to consider while choosing a mutual fund scheme.

Every day AMC has to upload its total TER charged for every scheme on AMFI (Association of Mutual Funds in India) and their own website. In India, there is no limit on the particular percentage of any expense ratio charged by the AMC but there exists a limit on the TER on equity and debt funds which should be charged based on the AUM (Assets Under Management) any mutual fund fund house is handling and these rates were last decided on April 1, 2020.

Calculation of Expense Ratio

1. Let's take an example that the AUM (Assets Under Management) of an equity mutual fund is ₹1000 crores and the total expense on it will be ₹19 crores. Then, the expense ratio will be calculated as total expense divided by AUM which is 1.9% in this example. This means that every investor associated with this scheme has to pay every day this much percentage as an expense ratio.

1. So, how much amount will you pay every day in this equity mutual fund? Let’s take this example further and suppose you have invested ₹50,000 in this fund on 12th December, 2022 and your investment grows in two days. So, the expense ratio for each day will be calculated as follows-

Date

Value of investment

Calculation

Expense Amount

13-Dec-22

• 50,800

(1.9%/365) X 50,800

• 2.64

14-Dec-22

• 50,500

(1.9%/365) X 50,500

• 2.62

Therefore, you are paying some amount every day which is being deducted from your investment corpus by the AMC thereby reducing your returns by this expense amount. Therefore, it is important to check this expense ratio before you invest in any mutual fund scheme.

Conclusion

It has been clearly seen that higher the expense ratio, the lower your returns from the scheme. You cannot go away from this expense whether you are earning returns or not. Every day you have to pay this much prescribed percentage. Its analysis can be seen as a way to compare different mutual fund schemes. The fund with a lower expense ratio should be selected based on other criterias as well.