When two people invest in the same mutual fund but get different returns, the reason is often not immediately obvious. This reason is the expense ratio. It’s a fee in mutual funds that is deducted silently every day. In this blog, you will understand what an expense ratio is in a mutual fund, how it is charged, and why the expense ratio in mutual funds affects your returns in the long run.
What Is Expense Ratio in Mutual Funds?
The total cost of managing a mutual fund is called the expense ratio. The fund house charges this fee for various services, including deciding where to invest your money, when to buy and sell, conducting research, and maintaining records. This cost, expressed as a percentage, is the expense ratio.
For example, if you invest ₹1,00,000 in a mutual fund with an expense ratio of 1%, approximately ₹1,000 will be deducted annually as management fees. This deduction happens gradually and is reflected in the NAV. This is why, over the long term, the expense ratio impacts your overall returns, even if it seems small in percentage terms.
What Does the Expense Ratio Actually Pay For?
- Fund Manager and Research Team Expenses : Investment decisions in mutual funds are made by the fund manager and their research team. The costs associated with company analysis, portfolio review, and market tracking are included in the expense ratio.
- Portfolio Management and Technology Costs : Managing a fund requires data systems, analytics tools, and trading infrastructure. The expenses incurred on these technical resources are also part of the expense ratio.
- Record Keeping and Regulatory Compliance : Maintaining investor records, calculating NAV, conducting audits, and complying with SEBI regulations are essential. These administrative costs are also included in the expense ratio.
- Distribution and Marketing Costs (Regular Plans) : In regular mutual fund plans, commissions are paid to distributors and advisors. This is why the expense ratio of regular plans is higher than that of direct plans.
Read Also: How to Compare Mutual Funds in India?
How Expense Ratio Is Charged ?
The expense ratio is not deducted by the mutual fund all at once at the end of the year. This expense is deducted daily in small increments from the fund’s value throughout the year. This is why investors never see a separate charge.
| Description | Statistics |
|---|---|
| Your investment | Rs 1,00,000 |
| Fund’s Expense Ratio | 1% annually |
| Total annual expenses | Rs 1,000 |
| Daily expenses | Approximately Rs 2.74 |
This means that the mutual fund adjusts its Net Asset Value (NAV) by approximately ₹2–3 every day. This amount is so small that it’s not noticeable on a daily basis, but by the end of the year, this expense adds up to ₹1,000.
Now imagine if this investment continues for 10–15 years. Then this expense is not limited to just ₹1,000; due to compounding, it also reduces your potential returns.
This is why, even though the expense ratio may seem small, its impact can be quite significant in the long run.
Direct Plan vs Regular Plan: Expense Ratio
| Point | Direct Plan | Regular Plan |
|---|---|---|
| Expense Ratio | It is less | It is higher than direct plan |
| Commission | No commission | Commission to Distributor/advisor |
| How does investing work? | Directly from AMC | Through a broker or advisor or distributor |
| Right for whom? | Those who have an understanding of investing themselves | New investors who need guidance |
How Expense Ratio Impacts Long-Term Returns ?
For example, there are two mutual funds. Both have an annual gross return of 12%, the only difference being the expense ratio.
| Description | Fund A | Fund B |
|---|---|---|
| Annual Return (before expenses) | 12% | 12% |
| Expense Ratio | 0.5% | 1.5% |
| Net Return | 11.5% | 10.5% |
| Initial investment | 1,00,000 | 1,00,000 |
Estimated value after 10 years:
- Fund A: Approximately ₹2.97 lakh
- Fund B: Approximately ₹2.72 lakh
Estimated value after 20 years:
- Fund A: Approximately ₹8.73 lakh
- Fund B: Approximately ₹7.33 lakh
The difference here is only a 1% expense ratio, but over 20 years, it amounts to a difference of approximately ₹1.4 lakh.
Read Also: Mutual Fund Fees & Charges in India
Common Myths About Expense Ratio
Myth 1: Low Expense Ratio = Best Fund
A low expense ratio can be a good sign, but choosing a fund solely based on this is not advisable. Sometimes, a fund with a slightly higher expense ratio can deliver better returns in the long run due to a superior strategy and disciplined management.
Myth 2: If the Returns are Good, the Expense Ratio Doesn’t Matter
This is a common misconception. The expense ratio is deducted from your returns every year. While the returns might look good today, if the expenses are high, those expenses will slow down your compounding over the long term.
Myth 3: The Impact of Expense Ratio is Less on One-Time Investments
Whether it’s a Systematic Investment Plan (SIP) or a lump sum investment, the expense ratio applies to both. The longer the investment is held, the more pronounced its impact will be. Therefore, the expense ratio should not be taken lightly even in the case of a one-time investment.
Conclusion
The expense ratio seems small, so people often don’t take it seriously. The difference isn’t noticeable at first, but over time, these expenses gradually reduce your returns. Therefore, when choosing a mutual fund, don’t just focus on high returns; understand how much you’re paying for those returns. That’s the smart approach.
| S.NO. | Check Out These Interesting Posts You Might Enjoy! |
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| 1 | Types of Mutual Funds in India |
| 2 | Mutual Fund Factsheet: Definition And Importance |
| 3 | Equity Mutual Funds: Meaning, Types & Features |
| 4 | What Is An IPO Mutual Fund? Should You Invest? |
| 5 | Who Regulates Mutual Funds in India? |
Frequently Asked Questions (FAQs)
What is the expense ratio in a mutual fund?
It’s the cost of running the fund, which is adjusted from your investment.
Does the expense ratio get deducted from my bank account?
No, it’s gradually included within the NAV (Net Asset Value).
Is a low expense ratio always good?
Often yes, but it’s also important to consider the fund’s performance and management.
Does the expense ratio really matter in the long term?
Yes, its impact becomes clearly visible over time.
Why is the expense ratio higher in regular plans?
Because it includes the advisor’s or broker’s commission.
