How to assess whether your mutual fund’s expense ratio is optimal

Mutual funds charge a fee called an expense ratio to cover their costs. The fees cover expenses such as operating fees, management fees, advertising fees, registration fees, administrative fees, audit fees and asset allocation fees, among others .

That said, sometimes mutual funds charge higher expense ratios for the same fund category. This is why it becomes important to find the right fund with the lowest expense ratio, which can also meet your return goals.

The Securities and Exchange Board of India (Sebi) has set an upper limit on the total expense ratio (TER). The Sebi mutual fund regulations specify the permitted limits of TER that can be charged by a mutual fund asset management (AMC) company. The highest TER is set at 2.25% for equity mutual funds that have less than Rs 500 crore in assets under management (AUM).

Mutual funds with a low AUM can have a high TER, and funds with a higher AUM are capped at a low expense ratio.

Therefore, opting for a fund with a larger AUM may reduce the amount you spend to acquire the net asset value (NAV) of the shares.

The expense ratio may seem like a small amount, but in the long run, these fees will impact your refund amount. Additionally, with a lower spend ratio, you also get more units.

Mutual funds with the lowest expense ratios

Passive mutual funds have the lowest expense ratios. These are mutual funds, which are based on a particular index. Exchange-traded funds (ETFs), funds-of-funds (FOFs), and some factor funds fall into this category.

In October 2022, index funds and ETFs (excluding gold) raised Rs 9,920.44 crore in investments from retail investors. These funds have the lowest expense ratio because they only track an index and do not actively pick stocks.

That said, one can build a diversified portfolio using passive funds.

One can invest in index funds if one is a long-term investor looking for a low expense ratio.

If you don’t want to invest in simple index funds, you can also invest in factor funds. Some of these factor funds are based on certain National Stock Exchange (NSE) indices, such as Nifty Momentum and Nifty Value.

Therefore, these factors can be used to select valuable or dynamic stocks without paying high expense ratios. Some fund houses also have their own factor investing products, such as low volatility funds, but these products have a somewhat higher expense ratio.

Expense ratio impact

These fees are deducted from the fund house’s income before they are distributed to investors. As this has a direct relationship to the return earned, it is essential to properly review mutual funds before investing.

For example, suppose you put Rs. 10,000 into a fund with an expense ratio of 1%. This implies that you have to pay Rs. 100 to fund house to manage your investments.

Sallie R. Loera