What is Total Expense Ratio?

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  • 15 Sep 2023

Mutual funds have evolved as a popular choice for Indian investors seeking to grow their wealth over the long term. However, before diving into the world of mutual funds, it's crucial to grasp their various costs. One of the most critical metrics in this regard is the total expense ratio (TER).

TER is a critical metric indicating the total cost of managing a mutual fund scheme. It is expressed as a percentage of the scheme's average assets under management (AUM). In essence, the TER is an annual fee that mutual fund investors pay to cover the fund's operating and management expenses.

TER in mutual funds encompasses various costs, including:

  1. Management Fees: It's paid to the Asset Management Company (AMC) for managing the fund's portfolio. They cover the salaries of fund managers and research analysts, among other expenses related to investment management.

  2. Administrative Expenses: Administrative expenses include costs incurred for record-keeping, customer service, legal compliance, and other administrative functions.

  3. Marketing and Distribution Expenses: These expenses are related to marketing and distributing the fund to investors. They may include commissions and fees paid to distributors and agents.

  4. Fund-related Costs: This category covers costs associated with purchasing and selling securities, including brokerage fees and transaction costs.

The TER directly impacts an investor's returns. Since it is deducted from the fund's AUM, a higher TER translates into lower returns for investors. Therefore, understanding the TER is crucial for making informed investment decisions.

A lower TER can significantly benefit investors, leaving more of their investment to grow over time. For long-term investments, even a seemingly small difference in TER can result in substantial variations in returns over the years.

When evaluating mutual funds in India, here are some key considerations regarding the TER:

  1. Comparative Analysis: Compare the TER of a specific fund with others in the same category. Lower TER funds are generally more cost-effective.

  2. Historical TER: Analyze the historical TER of the fund to assess whether it has remained relatively stable or increased over time. A sudden increase in TER could be a red flag.

  3. Performance vs. TER: Consider the fund's historical performance relative to its TER. If a fund consistently outperforms its benchmark despite a slightly higher TER, it may still be a worthwhile investment.

  4. Direct vs. Regular Plans: In India, mutual funds offer both direct and regular plans. Direct plans typically have a lower TER than regular plans because they do not involve distributor commissions. Direct plans can be cost-effective if you are comfortable managing your investments without a distributor's assistance.

  5. Risk-Adjusted Returns: Evaluate a fund's risk-adjusted returns to see if a favorable risk-return profile accompanies the lower TER.

  6. Exit Load: Keep in mind that some funds may have an exit load, which is a fee charged when you redeem your investment before a specified holding period. Consider the exit load in addition to the TER when assessing the overall cost of investment.

SEBI, the regulatory authority for India's mutual fund industry, has established guidelines governing the maximum expense ratios permissible for mutual fund houses to levy on investors. Presently, these prescribed expense ratio limits for various types of mutual funds are as follows:

AUM Size (in INR Crores) TER of Equity-Oriented Funds TER of Other Mutual Funds, excluding ETFs, Fund of Funds and Index Funds
0 - 500
2.25%
2%
500 - 750
2%
1.75%
750 - 2000
1.75%
1.5%
2000 - 5000
1.6%
1.35%
5000 - 10,000
1.5%
1.25%
Above 50,000
1.05%
0.8%

While TER is important when investing in mutual funds, it should not be the sole determinant of your investment decision. Investors should take a holistic approach and consider several other factors to make informed investment choices. Here are some key considerations to keep in mind:

  1. Investment Objectives: Your investment goals and time horizon are crucial in selecting the right mutual fund. Different funds cater to different objectives, such as wealth creation, income generation, or capital preservation. Ensure that the fund's investment strategy aligns with your goals.

  2. Risk Tolerance: Assess your risk tolerance before investing. Some funds may have higher TERs but also offer potentially higher returns, which may be suitable for investors with a higher risk appetite. Conversely, if you have a lower risk appetite, you might prefer funds with lower TERs, even if the expected returns are more moderate.

  3. Performance: Past performance is no indication of the future, but it can provide insights into how a fund has historically performed relative to its benchmark and peer group. Compare a fund's historical returns and risk-adjusted performance to see if it aligns with your investment objectives.

  4. Fund Manager's Track Record: Evaluate the fund manager's experience and track record. A skilled and experienced manager can potentially navigate market fluctuations and deliver consistent returns.

To Conclude

As evident, a lower TER can lead to higher returns over the long term, making it an essential for successful investment. By understanding and analyzing the TER, investors can make more informed decisions and maximize their wealth-building potential through mutual funds.

FAQs on What is Total Expense Ratio

Greater TER results in reduced returns. A higher TER means that a larger portion of your investment covers the fund's operating expenses. This reduces the amount of money available for investment in securities. Over time, these expenses can eat into your returns, resulting in lower overall gains.

It is assessed as a portion of the scheme's total assets. Fund houses calculate the Net Asset Value (NAV) of the fund by subtracting the TER daily. The TER directly impacts the overall return you receive from the Mutual Fund, with a higher TER resulting in increased expenses.

From the investor's perspective, an ideal expense ratio falls within the range of 0.5% to 0.75% for an actively managed portfolio. Any expense ratio exceeding 1.5% is deemed high.

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