Expense ratio should not be the main criterion of choosing a mutual fund
Liquid funds charge the least expense ratio, and equity funds charge the mostAs the size of a fund goes up, the expense ratio goes down as the incremental cost of managing the funds decreases with asset size
What is expense ratio? Does it impact the net asset value (NAV) of a mutual fund scheme? Should the expense ratio be high or low for me to make more money?
—Naina Sutaria
Expense ratio is the measure of fee charged by the mutual fund company or the asset management company (AMC) to manage your investment money. Such fees range from around 0.10% to 2.5% per year, depending on the type and size of funds that you invest in.
Liquid funds charge the least expense ratio, and equity funds charge the most. As the size of a fund goes up, the expense ratio goes down as the incremental cost of managing the funds decreases with asset size. Expense ratio is deducted from the corpus of the fund on a daily basis (as a tiny fraction of the annual expense ratio). This ensures that each investor pays fees that are exactly proportional to the number of days that they stay invested in a fund. This deduction eventually reflects in the NAV of the fund since the NAV is calculated by dividing the total assets of the fund by the number of outstanding units. So, as the total assets are slightly decreased every day to account for the fees, so does the NAV.
The lower the expense ratio (also called total expense ratio or TER) of a scheme, the higher the profits of the investment that accrue to the investor.
However, TER should not be the main criteria in terms of choosing funds, especially when it comes to managed funds (as opposed to index funds). A well-managed fund would likely return higher post-fee returns than a poorly managed one. That said, if there are two funds that are similar in terms of risk and return profiles, then choosing the one with lower TER would be the wise thing to do.
Srikanth Meenakshi co-founder, FundsIndia.com, (he is no longer with the firm).
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