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I invested in a fund with an expense ratio of 1% for three years (systematic investment plan @ 10,000 per month), and am planning to switch to a fund with 0.1% expense ratio in the fourth year before withdrawing the amount at the end of the fifth year. The yearly investment is 1,20,000 and overall investment for five years will be 6,00,000. The expected return is 10%. How will the expense ratio be calculated, and how does the deduction happen?

— Manoj

The only thing that investors need to know about expense ratio is that high expense ratios are bad and lower expense ratios are good when comparing funds of a similar nature and performance. That is, if you have two good funds that are performing well and they fit in your portfolio, please choose the one with the lower expense ratio, especially if the difference is significant.

Everything else about expense ratio is managed by the mutual fund companies (AMCs)—this is done in a fair and equitable manner. The expense ratio is charged on a daily basis as a deduction on the net asset value (NAV), which means two things; one, the expense applies uniformly to any investor who is holding units in that scheme on that day and, two, an investor pays fund management expense in proportion to the number of days that they hold units in a scheme.

For example, if a fund’s expense ratio is 2%, and you hold the fund for 6 months, you will pay (close to) 1% as expenses. It is not an explicit charge on your holding, and you don’t pay it at the time of redemption. It is taken out of overall investment corpus of the fund by reducing the NAV value.

So, in your case, you paid 1% of each of the 3 years of one fund, and 0.1% for the 4th and part of the 5th year until redemption. Each scheme charges expense ratio separately. There is no overall expenses charged at specific time periods. And the deduction happens, as I mentioned, by reducing the NAV of the fund marginally on every business day during which you held the fund.

Srikanth Meenakshi is co-founder, PrimeInvestor.in

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