Investing in Mutual Fund? And Confused about the expense ratio? Scroll to Know
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"Mutual fund investments are subject to market risk. Please read all the related documents carefully before investing". The Government warns all of us about the market risk in mutual fund investment through its marketing campaign but do you know about one more risk included in mutual fund investments?
Well, it's the charges that fund houses levy on investors that most investors are unaware of. That's why in this article we have put together everything about expense ratio which helps investors to identify the charges deducted by fund houses and make smart decisions while choosing the right fund. Before jumping right on our topic let's understand the basics of mutual funds.
What is a Mutual Fund?
Mutual funds are investment vehicles created by different asset management companies consisting of stock, bonds, and other securities. To put it in simple words When you deposit your money in any mutual fund scheme according to your future goals, the fund manager invests that money in stocks, bonds, debt instruments, etc. by analyzing the market and taking the risk factor in mind. AMC diversifies the portfolio to reduce the risk. Mutual fund investments beat the inflation, reduce the risk, offer good returns, and diversify your investment and that's why it is rightly said "Mutual fund Sahi hai"
Now that you know the basics about mutual funds, let's understand what the expense ratio is and why it matters.
What is an expense ratio?
The expense ratio is the charge levied on mutual fund investors to fund houses' expenses like operating costs, management fees, allocation charges, marketing and advertising cost, etc. This ratio is calculated by dividing funds expenses by their total assets.
It is important to check the expense ratio before investing in any fund as a greater expense ratio can reduce your overall returns.
How to calculate expense ratio.
Now that you know what the expense ratio is, let's find out how to calculate it and what it represents. Let's assume an asset management company has assets under management of Rs 100 crore for a particular scheme and the expenses they bear are 20 crores.
Therefore the expense ratio will be 20 crores divided by 100 crores I.e 0.2 %. So every investor will have to pay 0.2 % as the expense ratio to the asset management company.
So if you have invested 10000 and it grows by Rs 10 on the next day you will have to pay.
(0.2% / 365)*10010 I.e Rs. 5.49 Rs. Now that you have understood how to calculate expense ratio let's understand what its components are. Check through a calculator.
What are the components of the expense ratio?
Mutual funds are no doubt great investment options but it's really hard for beginners to find out about hidden and complex charges. So let's understand what the all-expense ratio consists of.
1. Legal/ Audit expenses.
An asset management company has to comply with thousands of rules and regulations. They have to take consultation with legal and fiscal experts to run their company. They are governed by the securities exchange board of India and hence they deduct these charges through expense ratio.
2. Fund managers fees.
The fund manager is the person who manages all the investors' money and allocates it to different asset classes. A good fund manager can assure good returns on your mutual fund investment. Active funds are managed by the fund managers but the passive funds are not managed by any person and that's the reason why passive funds have a low expense ratio.
3. Marketing and advertising fees.
Asset management companies do multiple campaigns for marketing and spreading awareness about the investments. These are the expenses of AMC and that's why they deduct them through expense ratio.
Top Mutual Funds by AUM in India: (Updated according to 2022 Reports)
Sr. No. | AMC | AUM |
1. | SBI Mutual Fund | Rs. 647064.29 Cr |
2. | HDFC Mutual Fund | Rs. 432084.97 Cr |
3. | ICICI Prudential Fund | Rs. 418258.02 Cr |
Why does the expense ratio matter?
The expense ratio has a direct impact on the net profitability of the fund. A higher expense ratio reduces investors' profitability due to higher expenses but a fund with a higher expense ratio does not imply that a fund is a better one. A fund with a low expense ratio can perform well as well. The expense ratio helps investors pick the right fund for them in different ways.
A larger fund can offer a comparatively lower expense ratio than a smaller fund because the larger asset is under the management of the larger fund. A direct fund has a lower expense ratio while a regular fund offers a higher expense ratio because of the distributor's fees included in regular funds.
While investing, two funds of the same category can also offer different expense ratios and in this case, an investor can make a quick decision to opt for a fund with a lower expense ratio as it will surely offer higher returns. That's how an expense ratio can help you pick the right fund for yourself to gain higher returns.
Conclusion
That was all you needed to know about the expense ratio. Make sure to check the expense ratio of your mutual fund investments and evaluate if your investment was a good decision or not. Also do not forget to ask about the expense ratio while investing in a mutual fund next time. Subscribe to our newsletter to know more about finance and business.
