Understanding Expense Ratio in Mutual Funds

Mutual funds charge an annual fee called the expense ratio, also known as management funds, to cover their costs. The fee covers expenses, which include operating costs, management fees, advertising costs, registrar fees, administrative expenses, audit fees and asset allocation charges, among others. Generally, the expense ratio is anywhere between 1-3% of an investor’s total investment.

However, at times, mutual funds charge higher expense ratios for a similar category of funds. It is, therefore, imperative to zero in on the right mutual fund with the lowest expense ratio, which aligns with the returns goals of an investor. 

Market regulator Securities and Exchange Board of India (Sebi) has fixed an upper limit on the total expense ratio (TER). The Sebi Mutual Fund Regulation specifies the permissible limits of TER that a mutual fund asset management company (AMC) can charge. The highest TER is set at 2.25% for equity mutual funds, which have lower than Rs 500 crore worth of assets under management (AUM).

Expense ratios are charges that are deducted from the mutual fund house’s revenue before it is distributed to the investors. Considering this has a direct impact on the returns earned, it is essential to properly examine the mutual funds before putting in the money for investments. 

For instance, if an investor puts Rs 20,000 in a particular mutual fund with a 2% expense ratio. The investor must pay Rs 400 to the mutual fund house to manage the investments. So, as an investor, the target should be to invest in a top-performing low-expense ratio mutual fund.