What is mutual fund expense ratio? This is the first question most investors ask before investing in a mutual fund. Because everyone wants to pay fewer charges.
I also check the mutual fund expense ratio before I invest in mutual funds.
What is mutual fund expense ratio?
The mutual fund expense ratio can be defined as the total annual fee borne by an investor by a mutual fund company. This fee varies from mutual fund to mutual fund. Mutual fund companies charge a specific amount per year to manage their money.
In general, an investor should pay a less expense ratio while investing in mutual funds. But this is not the only criteria to select the right mutual fund. Other factors include the type of fund, fund manager, previous record, scheme asset size, etc.
Components of mutual fund expense ratio
The mutual fund expense ratio is the expenses for operating a mutual fund company. And this is collected from the fund holders. There are specific plans in mutual funds. The fund managers manage the money they received from investors. For doing this, the mutual fund companies charge a fee, generally known as expense ratio, to investors.
The expenses include various fees (discussed below) for running a mutual fund company. The mutual funds recover these expenses from investors on a daily basis. But, the mutual funds clear it to the investors every six months, for example, what is mutual fund expense ratio.
The components of the mutual fund expense ratio may be divided into three categories. These are discussed below.
This fee includes the better management of a mutual fund company. This may also be called an investment advisory fee. In every plan of a mutual fund, at least one fund manager (sometimes more than one also) is there to manage the investor’s money. The fund manager may also be coordinated by some other people. In general, this fee is up to 1% of the total fund’s assets.
The administrative costs include the expenses for running the fund smoothly. For example, the expenses required for the keeping of records, customer support and service, and others. Again, the administrative costs vary from mutual fund to mutual fund and are expressed as a percentage of the fund’s assets.
The distribution fees include the expenses covered by advertising the schemes and other promotional effects. You would have seen the advertisements of different schemes of mutual funds to attract people to invest.
Many mutual fund companies collect distribution fees from investors to accomplish this.
The distribution fees are also known as 12-1b distribution fees.
The mutual fund companies promote their plans to people to purchase.
The above three fees are combined to form the expense ratio and are expressed as a percentage that is deducted from the fund.
Impact of expense ratio
The expense ratio of a mutual fund significantly influences the fund’s returns.
A low expense ratio means fewer charges collected by a mutual fund from investors.
Similarly, a high expense ratio means a collection of higher fees.
An expense ratio of more than two may be considered as a high expense ratio.
Reference: Paytm Money
An expense ratio of 2 means a deduction of 2% of funds value every year. Suppose, in a year, a fund’s actual return is 12% and an expense ratio of 2, you will get only 10% return in that year.
Not clear? Take another example to clear your doubts.
If you invest INR 100000 in a mutual fund having an expense ratio of 2%, you need to pay INR 2000 to the mutual fund house to manage your invested capital.
SEBI (Securities and Exchange Board of India) regulations
Do you know who manages the mutual funds? It is the Securities and Exchange Board of India (SEBI).
All expenses of an asset management company must be managed within specific limits as per regulation 52 of SEBI Mutual Fund Regulations.
These regulations state that the total expense ratio allowed is:
First INR 100 crore (average weekly total net assets): 2.5%
Next INR 300 crore: 2.25%
Next INR 300 crore: 2%
And remaining: 1.75%
The limit for debt funds is 2.25%.
Moreover, the SEBI allows mutual funds to charge 30 basis points more as an incentive to penetrate smaller towns. These cities also enjoy an extra 20 basis points as exit load charges.
In most equity-based funds, the exit load is nil after a withdrawal of at least one year.
Reference: Paytm Money
Illustration (What is mutual fund expense ratio)
Suppose a mutual fund handles INR 1 crore in assets. And it collects INR 200000 as fees and other charges from fund holders.
Now the expense ratio is 2%.
Expense ratio = Total expenses / Total assets
Another mutual fund house handles INR 100 crore and collects INR 1.5 crore as charges including all.
Here, the expense ratio is 1.5%. Again, this expense ratio is lower than the previous one.
(Regarding what is mutual fund expense ratio)
It is very important to know the mutual fund expense ratio before you invest.
However, it is not the sole criterion to select a mutual fund scheme. You have to check a fund’s previous track record (returns).
However, a low expense ratio means fewer fees.
Do not forget this.
Always choose a fund with a good previous track record with a low or moderate expense ratio.
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