EXPENSE RATIO IN A MUTUAL FUND -WHY IT MATTERS A LOT

You Must Know the Expense Ratio of Your Fund!

You often hear that expense ratio of a fund is 2.5% or 2%, but in all that fine print, it tends to get lost somewhere and we, as investors, tend to underestimate the impact of this ratio on your mutual fund portfolio. Let’s discuss this topic today in detail, which could actually be a very important factor in selecting a fund.

What is Expense Ratio?

The expense ratio is a measure of what it costs an investment company to operate a mutual fund. This is expressed as a ratio of your overall investment with the fund. The largest component of the expense ratio is the fee paid to a fund's investment managers. The fees of the fund managers/advisors vary from fund to fund.

You may have heard your colleague or your boss, waving a finger at you and saying "There is no such thing as a free lunch". As customers you pay fee or charges for all services, you enjoy. Similarly, mutual funds too charge a fee for managing your money. For example, if you invest Rs 10,000 in a fund with an expense ratio of 1.5 percent, then you are paying the fund Rs 150 to manage your money.

This expense ratio tends to differ from fund house to fund house and even from scheme to scheme! Don't forget, the expense ratio is a fixed component whether a fund generates positive/negative returns you have to pay fees. Thus before investing in a fund you must know the expense ratio of that fund.

So all funds with lower expense ratios are great right? The fund philosophy also matters, a fund house focused on costs may lower expense ratio on matter of principle, a fund house wanting more AuM may drop expense ratios for a completely different reason. A low expense ratio does not mean a fund is better managed or vice versa. A good fund should have a combination of healthy returns across market cycles with minimal expenses.

Though the expense ratio is a very important factor in the selection of a fund; there are other factors like fund house pedigree, long-term track record and portfolio quality which hold vital importance in the process of fund selection. Only after ticking all these check boxes do we need to look at the expense ratio. Ideally as assets grow in a fund, expenses for the fund house tend to remain in a level plane. For example, for a factory to make more soap, more machines are need, but for a fund house, expense ratio tends not grow in line with AUM.

Where are details of the expense ratio mentioned?

You can find details for expense ratio in the offer document section or in a monthly fact sheet. The Key information Memorandum also has details for the recurring scheme expense.

Remember the old adage "Drops of water that makes an ocean", hence choose a fund which has a strong customer oriented philosophy....and a low expense ratio. A small difference in expense ratio matters a lot in selection of a fund, as that tiny amount, compounding over time can make a big difference.