Expense Ratio

Expense Ratio

Mutual funds are popular investment options that pool money from different investors to purchase a diversified portfolio of stocks, bonds, or other assets. However, investing in mutual funds comes with costs, including management fees, administrative expenses, and other charges. One of the most important costs that investors should pay attention to is the expense ratio.

The expense ratio of a mutual fund is the percentage of the fund’s assets that is used to cover the costs of operating the fund. These costs may include management fees, administrative expenses, legal and accounting fees, and other charges. The expense ratio is usually expressed as an annual percentage and is deducted from the fund’s assets on a regular basis.

A high expense ratio can significantly reduce the returns earned by investors in a mutual fund. Therefore, investors should carefully consider the expense ratio before investing in a mutual fund. Generally, lower expense ratios are better, as they leave more money in the fund to generate returns. However, it is important to remember that expense ratios vary by fund type and investment style, and investors should compare the expense ratios of similar funds to make an informed decision.

Expense Ratio is the ratio of expenses incurred by a scheme to its Average Weekly Net Assets. It is to understand how much of the investors money is going for expenses and what portions are getting invested. The lower the ratio, the better.

For example

A scheme has average weekly net assets of Rs 100 cr. and the scheme incurs Rs. 1 cr as annual expenses. The expense ratio would be calculated as 1/100 = 1%.

If scheme’s expense ratio is comparable to or better than similar schemes, then this scheme meets the criteria as a good investment, based on this parameter only.

If the scheme is performing well and its AUM increases to Rs. 150 cr in one year whereas its annual expenses increase to Rs. 2 cr, then its expense would be calculated as:   2/150 = 1.33%.

The expense ratio while comparing with its peer schemes must also be tracked over different time periods. Ideally as net assets increase, the expense ratio of a scheme should come down.