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Total expense ratio or TER is one of the most important aspects to understand when it comes to investing in mutual funds. The expense ratio is the all-inclusive cost that is debited to the Net Asset Value (NAV) on a daily basis and is a cost to the investor. Over longer periods of time, the expense ratio makes a difference.
Expense ratio is the sum total of all costs like the fund management costs, registry costs, administration costs, market and publicity costs etc. The costs are added up and debited to the NAV on a daily basis proportionately so that any person entering or exiting the fund does not have any undue advantage.
Let us take two similar funds. One has an expense ratio of 0.8%and the other has an expense ratio of 1.8%. As a result, the first fund gives returns of 13% annualized while the second fund just gives 12%. This is a simple approach, but will help you understand. Just look at the table below.
Monthly SIP | CAGR Returns | Tenure | Final Corpus | Wealth Ratio |
Rs.10,000 | 13% | 20 Years | Rs.114.55 lakhs | 6.06 times |
Rs.10,000 | 12% | 20 Years | Rs.99.91 lakhs | 4.16 times |
Let us just interpret this table. In the above case, just by opting for a similar fund with a lower expense ratio, the wealth creation is Rs.14.64 lakhs higher. In other words, in both cases, the total investment contribution is Rs.24 lakhs. However, in the case of fund with the lower expense ratio, the wealth creation is 6.06 times while in the case of higher expense ratio the wealth creation is just 4.16 times.
One thing that is clear from the above illustration is that lower expense ratio means lower costs and higher returns. Even a 1% difference in costs can make a big difference to the eventual corpus. How can you consciously lower your expense ratio. Here are 3 ways.
Writing in his now famous letter to shareholders in 2016, Warren Buffett richly appreciated lauded the role played by Sir John Bogle, founder of Vanguard Funds in creating wealth. According, to Buffett, Bogle had shown that it was possible to create massive wealth by just managing the expense ratios. Is it not surprising coming from a top quality stock picker and active investor like Buffett. Here is the wisdom in the argument.
Vanguard has been a passive investor in the sense it never gets into stock selection. Vanguard funds are based on the belief that it is hard to beat the market and much harder to select funds that beat the market. Hence Vanguard just focuses on investing in good indices which can give solid equity returns with minimal risk and very low costs. As said earlier, index funds don’t need to manage money actively, so costs are lower.
According to a study on index funds, Vanguard alone had saved over $600 billion for mutual fund investors since its inception. All this money had directly translated into wealth for the investors. That is why costs matter and is special coming from the greatest stock pickers and active investors of all time.
Interesting, expense ratio is not the only cost when you invest in mutual funds. Here are some other costs that you also have to bear.
Here is what SEBI has stipulated as chargeable TERs for different fund categories
AUM (Rs crore) | TER % (Equity Funds) | TER % (Debt Funds) |
0 – 500 | 2.25 | 2 |
500 – 750 | 2 | 1.75 |
750 – 2,000 | 1.75 | 1.5 |
2,000 – 5,000 | 1.6 | 1.35 |
5,000 – 10,000 | 1.5 | 1.25 |
10,000 – 50,000 | TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof | TER reduction of 0.05% for every increase of 5,000 crore AUM or part thereof |
>50,000 | 1.05 | 0.8 |
Finally, let us look at the funds with the lowest expense ratio. As explained earlier, you will find that most of these funds would be Direct Plans as they save on marketing and distribution costs of the investor.
Name of the Fund | Expense Ratio (%) | 1-Year Returns(%) |
Navi Long Term Advantage – Direct (G) | 0.38% | 33.55% |
ITI Long Term Equity Fund – Direct | 0.38% | 24.63% |
Mirae Assert Tax Saver – Direct (G) | 0.43% | 40.68% |
Quant Tax Plan – Direct (G) | 0.57% | 70.68% |
Edelweiss Long Term Equity – Direct (G) | 0.68% | 36.62% |
Kotak Tax Saver Fund – Direct (G) | 0.72% | 37.19% |
Mahindra Manulife ELSS – Direct (G) | 0.73% | 44.29% |
IDFC Tax Advantage – Direct (G) | 0.74% | 49.74% |
Tata India Tax Savings – Direct (G) | 0.74% | 34.57% |
Axis Long Term Equity Fund – Direct (G) | 0.74% | 32.84% |
The above table captures the equity funds with the lowest expense ratios in India. These costs do matter as over a longer term, they can make a substantial difference to your returns.
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