What is Total Expense Ratio (TER)? And Why is it Important?
To run any business, the owner needs to pay the operation costs. Similarly, mutual funds are owned by Asset Management Companies (AMCs) and managed by professionals. To ensure that the funds are managed well, the AMC has to incur costs.
These costs usually comprise of:
- Management fee of fund managers who track equity & debt markets, ensure your fund is meeting the scheme objectives
- Research & Development to ensure your fund always has the best components
- Fee paid to Register Transfer Agents (RTAs) who are responsible for issuing (buying) & selling of fund units.
- Legal & Marketing expenses
- Distribution expenses which are basically commissions, that a fund house pays to your distributor
Direct funds do not incur these distribution expenses, hence there are no commissions charged from the end-user (you).
Regular funds on the other hand incur expenses (commissions) paid to the distributor, and hence higher expense ratios.
How is Expense Ratio Calculated?
It is calculated by dividing the total expenses incurred by a mutual fund house by its assets under management.
Total Expenses incurred by AMC
— — — — — — — — — — — — —
Total Assets Under Management (AUM)
However, fund houses cannot charge irrationally from you, as SEBI (Securities & Exchange Board of India) has capped the upper limit on these expense ratios. For example, an AMC with less than 500 crores AUM, cannot have more than 2.25% as expense ratio.
How do expense ratios affect your investments & more importantly returns?
When you invest in mutual funds, you essentially buy units of the scheme at a certain Net Asset Value (NAV). This value is arrived at after reducing the expenses incurred by the fund house.
When you buy and sell your units at the current NAV (which is already adjusted against expense ratio), your returns will be affected accordingly.
Let’s take an example:
If you invested Rs. 20,000 in a scheme, that has 2% expense ratio, you are basically going to pay (or have it reduced from your returns) Rs. 400 over a year to the fund house to manage your investments.
Depending on the changing value of your investment, this expense ratio is charged till the time you are invested in the fund.
So, if this scheme earned 15% returns after 1 year and you decide to withdraw it, ideally your returns should come up to Rs. 3,000 (15% x 20,000). But with a 2% expense ratio, you will receive only 13% returns on investments, i.e. Rs. 2,600.
Impact of investing in Regular funds, on your returns:
Over time, with compounding, this difference in commission can have a massive impact on your returns.
Let’s take a look at the difference in expense ratios across categories of equity mutual funds.
Almost every category shows a difference of 1% in your returns. This 1% is the commission that a fund house would pay to your distributor would finally be reduced from your returns.
How does Paytm Money helps you save on commissions?
Choose to invest in direct funds, instead of regular funds, to save on commissions. For this very reason, on Paytm Money, we offer direct mutual funds exclusively, to ensure you get only the best from your investments.
Investing in direct funds makes a 1% difference to your returns. This can be a massive amount over a long period of time, thanks to compounding.
Direct funds are ideal for investors who know which funds to invest in.
Paytm Money Investment Packs offers schemes of only direct plans suited to your risk profile. Each pack is suited to a certain risk profile of investors & contains only direct mutual fund schemes. So don’t wait any further to put your hard earned money to work.
We hope you will make an informed decision about your investments after reading this post. Let us know if you have any questions in the comments below.
