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Why the expense ratio of mutual funds matters to investors?

Investing in mutual funds

One of the prominent advantages of investing in a mutual fund is that you can enjoy the knowledge and experience of experts who continuously monitor your investments. These experts handle portfolios of well-researched stocks that offer optimum returns. The cost of managing and handling your mutual fund investment by asset management companies (AMCs) is charged to your account. This cost of investing in a mutual fund is popularly known as the expense ratio.

To understand the expense ratio in a mutual fund, you need to get acquainted with how the mutual fund works, the different costs and fees, and the prescribed government regulations.

The key components of the expense ratio are as follows:

  • Management fees: The compensation paid to professionals who manage the portfolios and mutual fund scheme
  • Maintenance fees: The operational expenses incurred by an AMC in running the mutual fund scheme
  • Miscellaneous fees: The cost of sales, marketing, and advertisement to disseminate information about the mutual fund scheme

The above components are the main elements of the expense ratio. This cost is deducted from the total value of the asset before sharing returns with investors. There are other expenses, viz. exit load and brokerage fees charged over and above the expense ratio.

This collective cost is then calculated as a percentage of the mutual fund’s average net asset value called the expense ratio of a mutual fund. When deciding which mutual funds to invest in, you should consider its expenses and fees.

Impact of a fund’s expense ratio

When the mutual fund’s assets are small, the expense ratio is considerably high compared to the lower expense ratio for mutual funds with a more significant asset coverage. The high value of assets covers the expenses, and the burden of cost is spread over many investors.

SEBI Regulations

In April 2020, the Securities and Exchange Board of India (SEBI) laid down new regulations for AMCs and mutual fund managers. As per the regulations, SEBI has expressed a limit on the total expense ratio charged by an AMC depending on its average net asset values.

Asset value under management The expense ratio of daily net asset value (equity) The expense ratio of daily net asset value (debt)
First Rs. 500 crore 2.25% 2%
Next Rs. 250 crore 2% 1.75%
Next Rs. 1,250 crore 1.75% 1.50%
Next Rs. 3,000 crore 1.60% 1.35%
Next Rs. 5,000 crore 1.50% 1.25%
Next Rs. 40,000 crore Decrease of 0.05% for every increase in assets under management (AUM) of 5,000 crores or part thereof Decrease of 0.05% for every increase in AUM of 5,000 crores or part thereof
Above Rs. 50,000 crore 1.05% 0.80%

The expense ratio eats away at the returns from the portfolio, but it is not the only factor to consider while investing. Investing in mutual funds requires some research on your part to select the best options that suit your financial goals, standing, investment horizon, and risk tolerance.

If narrowing down on the best mutual fund options based on your investor profile seem a bit tricky for you, it is prudent to reach out to a financial advisor who can curate bespoke investment plans for you.

Reach out to one and begin your investment journey today!

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