Why is the expense ratio of a mutual fund scheme important?


One element which investors take into account while choosing one mutual fund scheme over the other is the expense ratio.

What does the expense ratio in a mutual fund mean?
This ratio measures the per-unit cost of managing a fund. The fund’s total expenses are divided by its assets under management (AUM) to arrive at this ratio. Various costs incurred by the fund house are part of the expense ratio. For example, there is a fund management team that tracks the equity and debt markets and companies in the portfolio. The fund house also incurs expenses such as registrar, custodian, legal, audit fees, and fees to be paid for marketing and distribution of its products.

These costs are recovered through its unitholders daily and the daily net asset values (NAVs) of a fund scheme are reported after deducting them.

Why is there a difference in expense ratio between regular plan and direct plan?
In a direct plan of a mutual fund scheme, you buy directly from the fund house, whereas in a regular plan you buy through an intermediary such as an advisor or distributor.In this regular plan the fund house pays a commission to the intermediary, which is then recovered as an expense ratio from the plan. Hence, the expense ratio is higher for a regular plan.

What is the ceiling set by the market regulator for the expense ratio?
Sebi has set a ceiling based on AUM for open-ended equity-oriented MF schemes. For the first `500 crore, it is 2.25%; for `500-750 crore, 2%; for `750-2,000 crore, 1.75%; `2,000-5,000 crore, 1.6%; `5,000-10,000 crore 1.5%; for `10,000-50,000 crore, a reduction of 0.05% for every increase of `5,000 crore and for

AUM over `50,000 crore, 1.05%. Fund of funds investing in liquid, index and ETF schemes can charge a maximum of 1%.

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Does expense ratio impact fund returns?
The expense ratio indicates how much the fund charges in terms of percentage annually to manage your investments in the scheme. If you invest `10,000 in a fund that has an expense ratio of 2%, then it means that you are paying `200. Simply put, if a fund earns 15% and has an expense ratio of 2%, then you would earn a return of 13%. A lower ratio means more profitability and a higher ratio means less profitability.





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