Expense Ratio

Basics of Expense Ratio

What is Expense Ratio & How it Works?

Expense Ratio is a charge paid by an investor to an Asset Management Company for managing her money. It’s an ongoing expense and charged as a percentage of net assets of the fund. In India, according to SEBI guidelines, mutual fund houses are allowed to charge maximum of 2.5% as expense ratio in case of Equity funds and 2.25% in case of debt funds.

On and average, most of the equity mutual funds charge you anywhere between 1.5-2% of expense. In case of Index funds, it is 1-1.5%.

What are the Constituents of Expense Ratio?

01) Management Fee – CEOs, fund managers and sales and distribution personnel.

02) Administrative Costs – Expenses such as custodian charges, legal and audit fees, marketing and selling expenses

03) Trail Fee – is the commission that a distributor gets from the fund house till the money is invested with the fund house. It is generally paid on a quarterly basis and is generally 0.5% of the asset value.

Why Expense Ratio is important for Investors?

Expense ratio affect the over all return from the mutual fund. It is not very important in emerging markets like India and china which gives 20-60% Annual Returns…!!!!

But it is extremely important in Developed markets such as USA & Europe which gives hardly 6-10% annual return. The Index funds have low Expense ratio and thus they give more returns than any other funds in the long run in developed markets.

In fact, Vanguard Index Mutual Funds in USA are based on low Expense Ratio logic only.