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20.1 Expense Ratio

When you invest in a mutual fund, it might feel like you’re simply putting money into a pool that grows over time. But behind the scenes, there’s an entire infrastructure working to manage that money—fund managers making decisions, custodians safeguarding assets, administrators handling compliance, and distributors ensuring the fund reaches investors. Just like any service, this management comes at a cost, and that cost is captured in what’s called the Expense Ratio or Total Expense Ratio (TER).

Think of it like hiring a professional team to run a restaurant. You don’t just pay for the food ingredients—you also cover salaries, rent, electricity, marketing, and a margin for profit. Similarly, when you invest in a mutual fund, you’re paying for the expertise and operations that keep the fund running. The TER is essentially the annual fee expressed as a percentage of your investment, deducted directly from the fund’s assets.

For example, suppose a fund charges a TER of 1%. If you invest ₹1,00,000, the annual cost is ₹1,000. But instead of billing you directly, the fund quietly deducts this amount on a daily basis from the Net Asset Value (NAV). So, every day, a small slice—about ₹2.74 in this case—is shaved off your investment. You don’t see a separate charge, but the NAV you track already reflects this deduction.

This means the NAV you see is always after expenses. Whether the fund gains or loses value, the TER is applied consistently. Regulators like SEBI set maximum limits on TER depending on the type of fund and its size, ensuring investors aren’t overcharged. Under SEBI’s revised framework effective 1 April 2026, these limits apply to a ‘base expense ratio’ (BER), while statutory levies such as GST, STT and stamp duty are charged and disclosed separately. Specialized fund accounting firms help AMCs calculate these charges accurately.

As an investor, you don’t need to master the complex math behind TER. What matters is understanding that it reduces your returns slightly, and comparing TERs can help you make smarter choices. For instance, if two funds are otherwise identical in strategy and performance, choosing the one with the lower TER will leave more money in your pocket over time.

Imagine you invest ₹10,00,000 in Axis Large Cap Fund (formerly Axis Bluechip Fund). Assume, for illustration, that it delivers a gross return of 12% annually before expenses. Now, let’s compare two scenarios:

Scenario A:Expense Ratio = 1%
Scenario B:Expense Ratio = 2%

After 20 years:

Scenario A:₹10,00,000 grows to about ₹80.6 lakh
Scenario B:₹10,00,000 grows to about ₹67.3 lakh

That 1% difference in TER has cost you about ₹13 lakh. This shows how even a seemingly small expense ratio difference compounds massively over time.

Table: Impact of TER on Long-Term Wealth

Investment	Gross Return	TER	Net Return	Value after 20 yrs
₹10,00,000	12%	1%	11%	₹80.6 lakh
₹10,00,000	12%	2%	10%	₹67.3 lakh

The lesson is clear: Expense ratio directly reduces your returns, and choosing funds with lower TERs can make a huge difference in long-term wealth creation.

20.2 Direct vs Regular Plans

To understand the difference between Direct and Regular mutual fund plans, imagine buying a book. If you purchase it directly from the publisher’s website, you pay the base price. But if you buy it from a bookstore, the price is higher because the store adds its margin. The book is the same, but the cost differs depending on the channel.

Mutual funds work in a similar way. When you buy directly from the Asset Management Company (AMC), it’s called a Direct Plan. The AMC doesn’t need to pay commissions to distributors, so the TER is lower. On the other hand, if you buy through a distributor (such as a bank, a mutual fund distributor or an online platform that earns commission), it’s a Regular Plan. Here, the AMC adds an extra layer of cost to compensate the distributor, making the TER higher. Direct Plans can be bought on the AMC’s website or app, through MF Central, or via execution‑only platforms; SEBI‑registered investment advisers also use Direct Plans and charge their fee separately.

For example, consider a popular equity fund. The Direct Plan might have a TER of 1.2%, while the Regular Plan charges 1.7%. That 0.5% difference goes to the distributor. Over years, this seemingly small gap can compound into a significant difference in returns.

Now, you might wonder why anyone would choose a Regular Plan if it’s more expensive. The answer lies in the value of advice. If you’re new to investing and rely on an advisor to guide you—helping with fund selection, portfolio rebalancing, and market updates—the higher TER is essentially paying for their expertise and handholding. For many beginners, this support is worth the cost. But if you’re confident in managing your investments, a Direct Plan is more efficient since you avoid distributor commissions.

Another common confusion is about NAVs. Direct Plans usually show a higher NAV compared to Regular Plans, even though both plans of a scheme started at the same NAV when Direct Plans were introduced on 1 January 2013. At first glance, the Regular Plan looks cheaper, but that’s misleading. NAV isn’t a “price tag”—it represents the value of the fund’s assets. Since Regular Plans deduct higher expenses, their NAV grows slower, making them less valuable over time. Direct Plans, with lower deductions, accumulate more value, hence the higher NAV.

In short:

Direct Plans = lower TER, higher NAV, better for self-directed investors.
Regular Plans = higher TER, lower NAV, but useful if you need advisory support.

Key Insights

Expense Ratiois the fee you pay for fund management, deducted daily from NAV.
Direct Planshave lower TER since there’s no distributor commission.
Regular Planscost more but provide advisory support.
NAVreflects the value of assets after expenses, not the “price” of the fund.

The concept of the expense ratio is deceptively simple yet profoundly important. Investors often underestimate its impact because it looks small — 1% or 1.5% seems negligible. But compounding magnifies this difference over decades. Imagine two funds, both delivering 12% gross returns annually. One has a TER of 1%, the other 2%. Over 25 years, the first fund grows ₹10 lakh into about ₹1.36 crore, while the second grows into only about ₹1.08 crore. That 1% difference has cost you roughly ₹27.5 lakh. This is why seasoned investors obsess over TERs.

The daily deduction from NAV is another subtlety. Investors rarely notice it because it’s baked into the NAV. Unlike brokerage fees, which are explicit, TER is invisible. This invisibility can lull investors into complacency. Regulators like SEBI cap TERs to protect investors, but within those caps, AMCs compete aggressively. Passive funds, like index funds and ETFs, usually have lower TERs because they don’t require active management. Actively managed funds justify higher TERs by promising superior returns, but whether they deliver consistently is the real question.

The direct vs regular plan distinction is equally critical. Direct plans empower self-directed investors by eliminating distributor commissions. Regular plans, however, serve a purpose for beginners who need guidance. The trade-off is between cost and advice. Over time, as investors gain confidence, many migrate from regular to direct plans. The higher NAV of direct plans is not because they are “expensive” but because they accumulate more value by shaving off fewer expenses. This subtlety often confuses new investors.

A practical example: Suppose you invest ₹5 lakh in a regular plan with a TER of 1.7% and another ₹5 lakh in the direct plan with a TER of 1.2%. After 15 years, assuming identical gross returns of 12%, the direct plan grows to about ₹23.3 lakh, while the regular plan grows to about ₹21.8 lakh. That’s a difference of about ₹1.5 lakh — enough to fund a year of college tuition. The lesson is clear: TERs matter, and direct plans are structurally superior if you can manage without advisory support.

Example – Direct vs Regular Plans

Suppose you invest ₹5,00,000 in SBI Equity Hybrid Fund. Assume a gross return of 12% annually (the TERs below are illustrative; check the fund’s latest factsheet for actual figures).

Direct Plan TER: 2%
Regular Plan TER: 7%

After 15 years:

Direct Plan:Net return ≈ 10.8% → Value ≈ ₹23.3 lakh
Regular Plan:Net return ≈ 10.3% → Value ≈ ₹21.8 lakh

That’s a difference of about ₹1.5 lakh purely due to distributor commissions embedded in the Regular Plan.

Table: Direct vs Regular Plan Comparison

Plan Type	TER	Net Return	Value after 15 yrs
Direct	1.2%	10.8%	₹23.3 lakh
Regular	1.7%	10.3%	₹21.8 lakh

This example shows why Direct plans are structurally superior for confident investors, while Regular plans may suit beginners who value advisory support despite the higher cost.

15.1 Why talk about bonds now?

We have just finished exploring debt mutual funds, which are essentially baskets of bonds managed by professionals. Before moving on to index funds, it makes sense to pause and understand bonds themselves. After all, debt funds are nothing but a collection of bonds, and if fund managers can buy them directly, so can you. Today, investors don’t need to rely only on mutual funds, there are stock exchanges, SEBI‑registered Online Bond Platform Providers (OBPPs) and, for government securities, RBI Retail Direct, all of which allow individuals to purchase bonds directly, much like buying shares. Understanding bonds at this stage helps you see the mechanics behind debt funds and gives you the option to invest without an intermediary.

Debt mutual funds are essentially collections of bonds. By learning bonds directly, you understand what fund managers are doing behind the scenes.

Example:

A debt fund like HDFC Corporate Bond Fund invests in PSU bonds such as Power Finance Corporation (PFC).
As an individual, you can also buy listed PFC bonds directly on NSE/BSE through your broker, or through a SEBI‑registered online bond platform.

This means you can bypass the AMC if you want more control, though you’ll lose professional management.

15.2 Looking at bonds before investing

Imagine you’re browsing the stock exchange website and come across bonds issued by a government-backed company, say Power Finance Corporation (PFC). Each bond issue has a unique identification number called an ISIN, much like a fingerprint. Clicking on a bond reveals details such as whether it is tax-free, its credit rating, issue date, maturity date, coupon rate, and face value.

For example, suppose a PFC bond carries a tax-free tag. This means the interest you earn annually is exempt from income tax, making it highly attractive for investors in higher tax brackets. Note that no new tax‑free bonds have been issued since 2015–16, so today they can be bought only in the secondary market on NSE/BSE. However, if you sell the bond before maturity at a profit, that gain is taxable as capital gains. For listed bonds held for more than 12 months, long‑term capital gains are currently taxed at 12.5% without indexation; gains on bonds held for 12 months or less are taxed at your income‑tax slab rate. Next, you notice the credit rating—say AAA from CRISIL. This rating signals that the issuer is extremely reliable in repaying its debt. Since PFC is a government-owned company (a Maharatna PSU under the Ministry of Power), so the risk of default is considered minimal, although its bonds are not explicitly guaranteed by the government.

Other details matter too. If the bond is marked as secured, it means the issuer has pledged assets against the borrowing, similar to how banks secure car loans against the vehicle. This reduces risk further. You’ll also see the issue date and maturity date—perhaps issued in 2015 and maturing in 2030, making it a 15 year instrument. Finally, the coupon rate tells you how much interest you’ll earn annually based on the bond’s face value. If the coupon is 7% and the face value is ₹1,000, you’ll receive ₹70 per bond each year until maturity.

Looking at Bonds Before Investing

Detail	Meaning	Example
ISIN	Unique identifier for each bond issue.	PFC bond ISINs begin with ‘INE134E’, PFC’s issuer code.
Tax-Free Tag	Interest exempt from income tax.	NHAI Tax-Free Bonds (2015–16 issue).
Credit Rating	Reliability of issuer.	AAA rating for PFC bonds.
Secured/Unsecured	Whether assets are pledged.	REC secured bonds backed by receivables.
Issue & Maturity Date	Tenure of the bond.	Issued 2015, maturing 2030 (15 years).
Coupon Rate	Annual interest on face value.	7% coupon → ₹70 per ₹1,000 bond.

Example: If you buy a PFC Tax-Free Bond (October 2015 issue, 15-year series, 7.52% retail coupon, AAA-rated), you’ll receive tax-free interest every year until it matures in 2030. (The 10-year series of the same issue, with a 7.36% retail coupon, matured in 2025.)

15.3.Yield to Maturity (YTM)

While the coupon looks straightforward, the real measure of return is the Yield to Maturity (YTM). Think of it like buying a rental property. Suppose you buy a shop for ₹50 lakh and rent it out for ₹5 lakh per year. That’s a 10% rental yield. But if you later sell the shop for the same ₹50 lakh, your net yield remains 10%. If you bought it at ₹55 lakh instead, your yield drops because your cost was higher. Conversely, if you bought it at ₹45 lakh, your yield rises because you paid less for the same rent.

Bonds work the same way. The coupon is fixed, but the price you pay for the bond changes in the market. If a bond with a ₹1,000 face value and 7% coupon is trading at ₹1,080, you still earn ₹70 annually, but your effective yield is lower because you paid more upfront. On maturity, you’ll only get back ₹1,000, not the premium you paid. That’s why YTM often differs from the coupon—it reflects the actual return considering both interest payments and the difference between purchase price and redemption value.

Yield to Maturity (YTM)

Scenario	Bond Price	Coupon (₹70)	Current Yield (Coupon ÷ Price)
Buy at Face Value	₹1,000	₹70	7%
Buy at Premium	₹1,080	₹70	~6.48%
Buy at Discount	₹950	₹70	~7.37%

Example:

If you buy a REC bond at ₹1,080, your yield drops below the coupon because you paid extra.

If you buy at ₹950, your yield rises since you paid less for the same coupon. Note: the yields in the table are current yields (coupon ÷ price). The YTM moves even further in the same direction, because the ₹80 premium is lost at maturity (pushing YTM below 6.48%), while the ₹50 discount is gained at maturity (pushing YTM above 7.37%).

Credit Risk Funds are the adrenaline junkies of the debt world. Their mandate is to invest at least 65% in lower-rated corporate bonds (AA and below, excluding AA+). These bonds pay higher interest because the issuers are riskier. The fund manager’s bet is that the company will not default and may even improve its credit rating over time. If that happens, the bond price rises, boosting the fund’s NAV along with the coupon income.

Picture a landlord renting out property to a tenant with a shaky financial history. The tenant agrees to pay double the rent to compensate for the risk. If the tenant stabilizes his income, the landlord benefits both from the high rent and from the improved reputation of the property. But if the tenant defaults, the landlord suffers a heavy loss. That’s exactly how credit risk funds operate.

The danger lies in concentration. Even within SEBI’s single-issuer limits (lower for lower-rated papers), some funds allocate large chunks to a single company. If that company defaults, the NAV can collapse overnight. For retail investors, this risk is unnecessary. Most personal financial goals—retirement, education, home purchase—can be achieved with safer debt categories. Credit Risk Funds are better left to institutional players who can absorb shocks. For individuals, avoiding them is the wiser choice.

High ratings are no guarantee either. DHFL was rated AAA until early 2019, was downgraded as its troubles grew and defaulted in June 2019. The losses hit many debt schemes, not only credit risk funds, which is why every debt investor should check the quality of the papers in a portfolio.

Credit Risk Funds

Aspect	Explanation	Example
Mandate	At least 65% in bonds rated AA & below (excluding AA+).	Nippon India Credit Risk Fund (formerly Reliance Credit Risk Fund).
High Yield	Lower-rated issuers pay higher interest.	Bonds of stressed issuers such as DHFL traded at high yields before default.
Concentration Danger	Large exposure to one issuer magnifies risk.	DHFL default in 2019 caused sharp NAV markdowns.
Suitability	Better for institutions, not retail investors.	Affected schemes suffered sharp losses and side-pocketing.

15.4 .Accrued Interest

Now let’s talk about accrued interest. Suppose a bond pays its annual coupon every 1st January. If you buy the bond in July, the seller has already held it for six months and earned half the year’s interest. To be fair, you compensate the seller for that portion by paying a slightly higher price, which includes accrued interest. When January arrives, you’ll receive the full coupon, even though you only held the bond for half the year. This adjustment ensures fairness between buyer and seller.

In bond markets, the settlement price (the amount you pay) includes accrued interest and is called the “dirty price.” The price excluding accrued interest is the “clean price.” For example, if the clean price is ₹1,020 and six months of accrued interest on a 7% coupon is ₹35, the dirty price you pay is ₹1,055. This mechanism ensures that the seller is paid interest for the period they held the bond, and the buyer earns interest only for the period they hold it.

Accrued Interest

Term	Meaning	Example
Clean Price	Price excluding accrued interest.	₹1,020
Accrued Interest	Interest earned by seller till date.	₹35
Dirty Price	Settlement price (Clean + Accrued).	₹1,055

Example:

A bond pays coupon every 1st January.
You buy in July → seller already earned 6 months’ interest.
You pay dirty price (includes accrued interest).
In January, you still receive full coupon (₹70).

15.5 .Should you invest in bonds?

Many investors lean heavily toward equities because of their growth potential. But market shocks—like the sudden crash during the pandemic—remind us that diversification is essential. When stock indices fell sharply, even many long-term SIPs briefly showed negative returns, leaving equity only investors exposed. Bonds, gold, and fixed deposits act as stabilizers in such times. They may not deliver spectacular returns, but they provide safety and predictable income.

Today, you can build a portfolio using a mix of assets: equities for growth, mutual funds for diversification, bonds for stability, gold for inflation protection, and fixed deposits for liquidity. The right blend depends on your goals—whether it’s wealth creation, retirement planning, or capital preservation. Bonds deserve a place in that mix because they balance risk and return, ensuring your portfolio doesn’t crumble during market downturns.

Should You Invest in Bonds?

Bonds stabilize portfolios during equity downturns.

Examples of Diversification:

Equities: Growth (Infosys, Reliance shares).
Bonds: Stability (PFC, NHAI tax-free bonds).
Gold: Inflation hedge.
FDs: Liquidity.

During the COVID-19 crash (February–March 2020), the Nifty 50 and Sensex fell about 38% from their January 2020 peaks. High-quality bonds and gilt funds cushioned portfolios, proving their stabilizing role.

15.6.Key takeaways

Tax-free bonds provide interest income exempt from tax (no new issues since 2015–16; they are available only in the secondary market).
PSU bonds generally carry low credit risk because of government ownership, though most are not explicitly government-guaranteed.
Coupon rate is fixed on face value, but actual returns depend on purchase price.
Yield to Maturity reflects the true return considering both coupon and redemption value.
Accrued interest ensures fairness between buyer and seller during coupon cycles.
Diversification with bonds and other assets protects against equity market shocks.

Mutual Fund Expense Ratio

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