Last Updated on
When you invest in a mutual fund a percentage of what you earn as returns is subtracted to pay for the fund manager, fund distributor, advertising and other expenses. This is referred to as expense ratio.
For example if you invest Rs. 1 lakh in a fund and if the fund returns 10% in a year the amount will grow to Rs. 1,10,000. If a mutual fund quotes an expense ratio of 1%, then 1% of 1,10,000, that is 1,100, will be deducted and the value shown in the statement will be 1,08,900. This represents a return of 8.9% (not 10% – 1% as you might think!). For an expense ratio of 2% the value will be 1,07,800 or a net return of 7.8%. A difference of only 1,100 one might think. For just a few years this does not matter much. Unfortunatelythe decrease in value due to the difference in expense ratios compounds if you stay invested for a long period of time. For example over a 15 year period the difference is 50,749 for 10% yearly returns. For 15% returns the difference is 98857.
Now consider a SIP investment of 5000 each month the MF with 1% expense ratio grows to 295463 and the MF with 2% expense ratio grows to 2667413 a difference of 10% or 2.91 lakhs!
So expense ratio is an important factor in selecting a mutual fund but not the only factor. Let us list the factors:
1 long term consistent performance over all market trends
2. good risk-return parameters: high alpha, low beta, low standard deviation and high Sharpe ratio
Download the step-by-step guide to selecting a mutual fund to find out what these ratios are.
3. Once you have short-listed funds on the basis of 1 and 2 you could choose the one with the lowest expense ratio.
Use this calculator to understand how expense ratios can impact returns over a long period.
Do check out these related articles:
About the Author
Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & Content Policy
Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. We operate in a non-profit manner. All revenue is used only for expenses and for the future growth of the site.Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
Our Publications
You Can Be Rich Too with Goal-Based Investing
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
The ultimate guide to travel by Pranav Surya
Free Apps for your Android Phone
All calculators from our book, “You can be Rich Too” are now available on Google Play!Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)
What are expense ratio in case of a ulip
in the first few years a ULIP has several charges like premium allocation, mortality, admin etc.
then it sort of settles down to a single fund management expense ratio of at least 1%, variable from policy to policy.
So if we know these charges from the offer document exactly we can calculate them in a table
I think the NAV announce will be after deducting expense ration. If we analyse the fund on the basis of Returns over longrun, what is the need to bother about expense ratio. For example, if Fund A returns are 10% (after expense ratio of 2%) and Fund B returns are 11% (after expense ratio of 5%), obviously we have to select Fund B (other things being equal). Here the returns are calculated on the basis of NAV (after deducting expense ration). Please correct me If Iam wrong.
SIVA PRASAD
Yes you are right about the NAV.
fund A with 11% return and 5% expense ratio has to provide absolute returns of 17% while fund B with 10% return and 2% expense ratio has to provide absolute return of only 13%. I can see possibilities:
1) fund A and fund B have very different risk return profile and hence cannot be compared
2) if they do belong in the same class then if down the line fund B gives absolute return of 17% the real return will become 14%
So by choosing fund A I am denying myself the possibility of earning more. This is likely becuase the difference in net return is only 1%
Of course if the difference in real returns is huge: fund A gives 15% and B 8% then despite high expense one can choose A.
The point is one should shorlist funds first on the basis of past performance and then on the basis of risk return profiles and the choose the one with lowerst expense ratio
Thanks for the nice question.
Hello,
Need a urgent help.
Hope i will get a reply soon.
I am new to MF investment. Currently have invested in BnP Equity Fund.
Now , todays NAV 58.21 is for Direct fund and 59.88 NAV for Regular Fund.
Regular fund NAV is higher to incorporate expense ratio : 2.8%
Now , my question is
1) when is the expense ration of 2.8% charged to the end user that is the customer?
a) is it charged when u redeem it?
b) is it charged annually separately and shown in the statements?
2) I have invested in SIP for 6 months now and plan to move to direct plan
But,
1) if the expense ratio is just reflected in the NAVs and not charged separately to the customer , then my calculations show me equal corpus at the end of 3 years
Please clarify.
Hello,
Need a urgent help.
Hope i will get a reply soon.
I am new to MF investment. Currently have invested in BnP Equity Fund.
Now , todays NAV 58.21 is for Direct fund and 59.88 NAV for Regular Fund.
Regular fund NAV is higher to incorporate expense ratio : 2.8%
Now , my question is
1) when is the expense ration of 2.8% charged to the end user that is the customer?
a) is it charged when u redeem it?
b) is it charged annually separately and shown in the statements?
2) I have invested in SIP for 6 months now and plan to move to direct plan
But,
1) if the expense ratio is just reflected in the NAVs and not charged separately to the customer , then my calculations show me equal corpus at the end of 3 years
Please clarify.