In an organization when there is a requirement of a portfolio manager then certain costs are being incurred which is considered as a management fee. This management fee is very high and consists of a great chunk of the management fees. Similarly, the cost of buying and selling any security is considered as a trading expense ratio. The combination of management and operational cost is what is the expense ratio in a mutual fund.
When it comes to mutual funds when an investor invests in any of the funds, it requires the management of that funds and also the fees are charged for buying and selling of the funds as well as for managing the funds by the mutual fund company and by combining both these fees it is termed as the expense ratio.
What are essential points to know about the expense ratio?
When the question arises of what the expense ratio in a mutual fund is, the answer lies in the fundamental understanding of a fund. An expense ratio refers to the fund’s annual operating expenses expressed as a percentage of assets. It depicts the share of assets dedicated towards operations and administrations. The expense ratios in mutual funds are regulated by SEBI.
As per the guidelines of SEBI, mutual fund companies are permitted to charge a certain amount for operating the funds. For the management of these funds high in-depth knowledge, expertise, and analytic skills are required. Thus, a group of people who have these skills manages the funds to provide better returns to the investors. These managers track the market and companies in the fund’s portfolio.
- Importance of expense ratio
The question of what is the expense ratio in mutual funds is directly linked to its importance. The expense ratio is important to an investor because it has a direct relationship with the investor’s funds and his returns. For example- An investor invests Rs 100000 and the expense ratio is 1%. It means INR 1,000 will be deducted from the returns but if the expense ratio increases from 1% to 2% then INR 2,000 will be deducted from the returns. Thus with the increase of just 1% of expense ratio, there is a decrease in the investors’ returns by INR 1,000. Thus a small change in the percentage of an expense ratio can have a huge effect on investors’ returns.
- What does the expense ratio include?
For an investor or a layman, an expense ratio is just a single expense or charge which is paid by an investor but if we study what is expense ratio in mutual fund in detail it includes a variety of expenses such as:
- Fund management
- Brokerage expenses
- Custodial expenses
- Marketing expenses
- Tax and services
- Business expenses
- Registrar and transfer expenses
- How is the expense ratio calculated?
The calculation for expense ratio is done when you divide the total amount of fund fees by the value of the fund’s assets.
- Nominal percentage
A nominal percentage of the expense ratio is about 0.5% to 0.75%. If the expense ratio goes above 1.5% then it creates a huge effect on the investors’ return.
- Is an investor required to pay an expense ratio?
No, an investor is not required to pay the expense ratio as it directly gets deducted from the returns, and only the net returns are received by the investor.
Unlike in other investments, the investor pays a fee for every transaction he does(Buying and Selling) but in mutual funds, the expense ratio is charged on an annual basis.
- Should the expense ratio be lower or higher?
If you understand what the expense ratio in mutual funds is accurately, you will find that if the expense ratio is greater then investors’ net profit will be decreased and their expense will be increased. On the other hand, if the expense ratio is low then it will increase the investors’ returns. A higher expense ratio also indicates that more resources are used to manage the assets and vice-versa.