Expense Ratio

Investing mutual fund is one of the best investment options available in the market. While you are investing in mutual funds, you must understand the terms associated with mutual funds. Mutual fund expense ratio is one such term that directly impacts your returns. Let us read in detail about mutual fund expense ratio, expense ratio, what is the expense ratio, and more in detail.

What Is Expense Ratio?

The expense ratio is the charge levied by the asset management company on the mutual funds for maintaining a pool of funds. The charges include annual operating costs such as allocation charges, management fees, advertising costs, etc.

How is Expense Ratio Calculated?

Expense Ratio = Total Expense/Average AUM

• Total expense = This includes expenses such as marketing, manager’s remuneration, distribution outlays, and legal and audit expenses incurred by the AMC.
• AUM (Average AUM) = This includes the overall value of the funds pooled by all the investors in a particular fund.

Expense Ratio Example

Suppose an XYZ company has a 1% expense ratio. This means the company is charging 1% of the total AUM for managing the mutual funds. If the total AUM is ₹10,00,000, the mutual fund charge will be ₹10,000 (1% of 10,00,000) as an expense ratio.

How does the Expense ratio work?

The expense ratio is charged for managing the mutual funds by the asset management company. Suppose, you have invested 10,000 in mutual funds with an expense ratio of 1%. The expense will be 100 (1% of 10,000) for managing the funds. The expense ratio will be charged even if you redeem the funds before one year.

What are the components Of the Expense Ratio?

Generally, 0.5-1% of the total asset base is deducted as management fees of a mutual fund. There are various components associated with an expense ratio that directly impact the returns on the mutual funds. Knowing these costs will help you plan your mutual fund investment better. Below are the various components of the expense ratio:

• Maintenance expenses

Maintenance expenses include the cost incurred for maintaining proper records of the investors. This includes entry and exit fees for the portfolio assets, customer support, etc. Maintenance cost ensures smooth operations required for maintaining the mutual funds.

• 12B-1 fee

12B-1 fee indicates the cost incurred on the promotion of the relevant mutual fund. The charge of a new individual investing in the mutual fund is included under the 12B-1 fee which is part of the total expense ratio.

• Entry Load

Entry Load is the amount paid by an investor while joining a mutual fund. As per recent SEBI regulations, the entry load is abolished from the calculations of the total expense ratio of a mutual fund. However, the entry load differs from the mutual fund. 

• Exit Load

Exit load is the amount charged when an investor withdraws from the mutual fund. The exit load usually stands at 2-3% which is payable on the total investment of the individual.

• Brokerage fees

Direct and regular plans are two plans of mutual funds. AMC hires a broker all the transactions related to the sale and purchase of the portfolio asset are considered a regular plan. Whereas, when you are managing the transactions, it is considered a direct plan. Brokerage fees add to the expense ratio of a regular mutual fund.

How Does the Expense Ratio Impact Fund Return?

The expense ratio impacts your fund returns as follows:

• Higher Expense Ratio: a higher expense ratio means the expenses or charges are higher which lowers the return.
• Lower Expense Ratio: A lower expense ratio means the expenses or charges are minimal this helps in maximizing your returns.

Expense Ratio Limit by SEBI

The expense ratio limits based on the type of funds and its AUM set by the Securities and Exchange Board of India (SEBI):

For actively managed Mutual Funds:

Source: https://www.amfiindia.com/investor-corner/knowledge-center/Expense-Ratio.html

For passively managed Mutual Funds: