Understanding expense ratios and how they affect your returns in 2024
If you are a mutual fund investor, you must be aware of the significance of expense ratios in helping the mutual fund house maintain the scheme. Go through this blog to know more about expense ratios including the regulatory limits imposed on fund houses by SEBI and the components of expense ratios.
What are expense ratios?
The Securities and Exchange Board of India (SEBI) permits mutual fund houses to charge certain operating expenses for managing a mutual fund scheme. These charges include expenses such as exit load, administrative expenses, and marketing/advertising expenses, and are collectively called TER (Total Expense Ratio). A fund’s TER is calculated as a percentage of its NAV (net asset value). Here is the formula used to calculate TER:
TER = (Total expenses for operating the fund) / (Average assets under management (AUM))
SEBI has imposed regulatory limits on the TER that can be charged by mutual fund houses. These rules have been mentioned under Regulation 52 of SEBI mutual fund regulations:
| AUM | Maximum TER as a percentage of daily NAV | |
| TER for Equity funds | TER for Debt funds | |
| On the first ₹ 500 crores | 2.25% | 2.00% |
| On the next ₹ 250 crores | 2.00% | 1.75% |
| On the next ₹ 1,250 crores | 1.75% | 1.50% |
| On the next ₹ 3,000 crores | 1.60% | 1.35% |
| On the next ₹ 5,000 crores | 1.50% | 1.25% |
| On the next ₹ 40,000 crores | TER reduction of 0.05% for every increase of ₹ 5,000 crores of daily NAV or part thereof. | TER reduction of 0.05% for every increase of ₹ 5,000 crores of daily NAV or part thereof. |
| Above ₹ 50,000 crores | 1.05% | 0.80% |
What are the components of a fund’s expense ratio?
A fund’s TER consists of the following charges:
- Fee for the execution of the fund manager’s investment strategy, also called as management fees.
- Administrative costs that cover the expenses of recordkeeping and accounting.
- Distribution and maintenance fees that cover the costs incurred for marketing and advertising the fund and maintaining the fund’s operational infrastructure respectively.
- Exit load fees which is a potential penalty levied upon the investor in the event of an early withdrawal.
- Legal fees, that covers for expenses incurred for legal compliance.
- The sum of all ongoing costs in managing the fund, called operating expenses.
How do expense ratios affect your mutual fund returns?
If you invest ₹ 1,00,000 in a mutual fund that charges an expense ratio of 2%, it means that you must pay ₹2,000 annually to the fund as ‘fund management charges’. Lower TERs generally result in higher returns for the investor. However, you must not select mutual funds simply based on the TER value. You must check its past performance, read about its management, and only then decide on whether or not to invest. If you opt for a mutual fund’s ‘regular plan’, you might have to pay a higher TER since you will be buying units through an intermediary (distributor) instead of buying them directly from the fund.
In conclusion, expense ratios constitute an important fee category in the context of mutual fund investments. While comparing mutual funds before investing in one of them, you must try to opt for the one with a lower expense ratio, since it will help you slightly improve your returns. You can use an online mutual fund return calculator to calculate your fund’s returns before investin
