Your mutual funds portfolio is a big decision. How many Systematic Investment Plans (SIP) should I have in my portfolio? Should I go for an actively managed SIP or index fund? What is the ideal percentage of my fund’s expense ratio? Let’s find out the TER of your SIP investment.
What is a Total Expense Ratio?
It is the percentage of a fund’s average net assets that is used to cover its operating expenses. Such expenses include management fees, administrative costs, marketing expenses and other operational costs to manage your mutual fund.
The expense ratio in mutual funds is deducted from that fund’s returns before they are distributed. So if an SIP investment has a higher expense ratio, the net returns decrease. Net returns are the gross returns after deducting the Total Expense Ratio (TER). This lowers the profitability of a mutual funds investment. Thus, you as an investor must look for funds with lower expense ratios.
For example, if your SIP returns are 15% and the TER is 1.25%. So your net returns from this SIP would be 13.75%. Hence knowing about your fund’s expense ratio is very essential.
Think of it like renting a flat. The flat you bought is your SIP investment. And the rental income is the returns you get. In this case, your TER is the maintenance charge that you pay for your flat.
What should my SIP’s Total Expense Ratio be?
In India, the Securities Exchange Bank of India (SEBI) controls the mutual funds market. It hasn’t set any limit on how much expense ratio can be charged but the TER must be within the prescribed limit. This limit has been specified for all Asset Management Companies (AMCs) under Regulation 52 of SEBI Mutual Fund Regulations. Here is the table:
Mutual funds investment are allowed to levy an additional charge of up to 30 basis points (bps) if the fresh investments from retail investors originating from cities beyond the top 30 (B30) cities constitute at least;
- 30% of the total new inflows in the scheme, or
- 15% of the average Assets Under Management (AUM year to date) of the scheme, whichever is greater. This initiative aims to promote investments into mutual funds from tier-2 and tier-3 cities.
Importance in Investment Returns
The TER is as important as a SIP investment return. This is so as it decides the profitability of an investment in mutual funds. A lower TER means that a smaller percentage of your investment is being deducted to cover the operating expenses of the fund, leaving more of the returns to compound over time. Consequently, a higher TER can eat into your investment returns. This would reduce the amount of money you ultimately receive.
How to calculate the Expense Ratio of a fund?
To find the expense ratio of a fund, you have to divide the total annual operating expenses by the average fund assets.
Let’s say a mutual fund has an average fund assets of ₹1,00,00,000 and its annual operating expenses are ₹50,000. In this case, the expense ratio is 0.005 or 0.5%.
What is the ideal Expense Ratio?
There is no single ideal expense ratio that applies to all funds. However, a lower expense ratio is usually preferred. The best expense ratio depends on many factors including the type of fund, size of the fund, your investment goals, risk tolerance and industry sectors.
Actively managed funds typically have higher expense ratios than passively managed funds. It is due to the fees charged by fund managers who actively manage AUM. And passively managed funds like index funds have lower expense ratios as they simply track a specific benchmark index.
What is know more about Index Funds? Click here.
If you invest in mutual funds with bigger AUMs, it is more likely that the TER of that fund will be lower. Bigger AUMs have the benefit of economies of scale. They can spread their fixed costs over a larger asset base, resulting in lower fees per investor.
Index funds have lower Expense Ratios
Passively managed funds, i.e., index funds follow an index, such as S&P 500. This ends the need for a team of analysts and portfolio managers to actively select and trade securities in stocks. Hence, this results in lower management fees.
So choosing index funds can be an easier form of investment with potentially higher returns and lower transaction costs.
FAQs
What is a good total expense ratio for a mutual fund?
A Total Expense Ratio (TER) is a measure of the cost of owning a mutual fund. It includes all fees and expenses charged by the fund, including management fees, administration fees and other expenses. A good TER for a mutual fund generally depends on the type of fund and your investment goals.
For example, a low TER for an index fund that tracks a broad market index may be appropriate, while a higher TER for an actively managed fund that seeks to outperform the market may be acceptable.
What is the base total expense ratio?
The base TER is a measure of how much of the premium paid on an investment is for covering the expenses of the investment. It is typically expressed as a percentage of the investment’s Net Asset Value (NAV).
What is a 0.3 expense ratio?
A 0.3 expense ratio means that an investor has paid out ₹0.3 in expenses for every rupee invested in the portfolio. This refers to the total cost of running the investment fund, including management fees, administrative expenses and other operational costs.
What is exit load?
Exit load is a term used to describe the cost of withdrawing funds from an investment before its maturity date. It is typically associated with mutual funds. If the investor tries to sell his/her shares before the investment’s maturity, it may incur a penalty. Exit load is usually expressed as a percentage of the NAV of the fund and can vary depending on the fund’s terms and conditions.
How much exit load is good?
The best exit load for a mutual fund is one that is as low as possible. However, mutual fund houses may charge an exit load to discourage short-term investments and promote long-term investing.
Who pays the expense ratio?
The expense ratio is paid by the investors in a mutual fund or Exchange-Traded Fund (ETF). This fee is deducted directly from the fund’s assets, so investors indirectly pay the expense ratio through their investment in the fund. The expense ratio covers the costs associated with managing and operating the fund.
Is TER included in NAV?
Yes, the TER is included in the NAV of mutual funds. TER is a measure of the fund’s expense structure, and it affects the fund’s NAV. NAV is calculated as the total value of the fund’s assets minus the total value of its liabilities, and it represents the price per share of the fund.
Does TER include GST?
TER includes the Goods and Services Tax (GST). As money management is a service provided by the Asset Management Company (AMC), it comes under the purview of GST, and the expense ratio of mutual funds is inclusive of GST.
Does TER include commission?
Yes, the TER does include commissions. They include commission, stockbroker fees, securities transfer tax and annual advisor fees.
What kind of mutual funds have lower expense ratios?
Index Funds have lower expense ratios since they are not actively managed by portfolio managers. They simply follow a benchmark index.
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