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Total Expense Ratio (TER): What is it & how does it affect your investments?

Lately, you must have received emails/ SMSes from the Mutual Fund houses about changes in the TER changes. As an investor it is important to know the various factors that can impact your returns. TER is one of those factors that directly impact your returns.

So, what is it?

Expense ratio indicates the amount you pay a mutual fund every year to manage your money (in percentage terms). It is the aggregate sum of expenses incurred to administer, manage or to meet any other expenses to run the fund. For example, if you invest Rs.100,000 in a fund with an expense ratio of 1%, then you are paying the fund Rs.1000 to manage your money.

Why is there a sudden focus on it?

The Securities and Exchange Board of India (SEBI) has been on a relentless drive to make the expense ratio figures more transparent and cut the cost of investment in mutual funds. The mutual funds are now required to notify its investors about any change in TER via a notice/email/ SMS at least three working days prior to the effective date to enable the investor to take informed decisions. For long-term investors in mutual funds schemes, every cost saving means higher returns.

How will it impact your returns?

The TER has a direct bearing on a scheme’s NAV – the lower the expense ratio of a scheme, the higher the NAV. Since this is charged regularly (every year), a high expense ratio over the long-term may eat into your returns massively through power of compounding. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if we consider an expense ratio of 1.5 per cent, your actual total returns would be Rs 3.55 lakh, nearly 14 per cent less than what would have been achieved without any expense charge.

All expenses incurred by a Mutual Fund house are managed within the limits specified under Regulation 52 of SEBI Mutual Fund Regulations. For actively managed equity schemes, the total expense ratio (TER) allowed is 2.5% for the first Rs.100 Crore of average weekly net assets; 2.25% for the next Rs.300 Crore, 2% for the subsequent Rs.300 Crore and 1.75 % for the balance AUM. For debt schemes, the expense ratio permitted is 0.25% lower than that allowed for equity funds.

However, while expense ratio is important, it should be borne in mind that it is not the only criterion while selecting mutual fund scheme. A scheme with a consistently decent track record, but a higher expense ratio may be better than the one which has a equal or lower expense ratio, but gives poor returns.

Choosing a right mutual fund is part of an investment portfolio. To have a right investment portfolio, it should sync with your financial plan. To create a sound financial plan for your financial goals, download the MoneyUp app here: