Total Expense Ratio

What is TER in Mutual Funds?

The Total Expense Ratio reflects the comprehensive cost of managing a mutual fund, covering everything from management to administrative services. It is expressed as a percentage of the fund’s average assets under management and is calculated after subtracting the applicable expenses from the fund’s total assets.

In simple terms, the TER tells you how much you are paying the fund house annually to manage your investment.
For example, if you invest ₹1,00,000 in a mutual fund with a TER of 1.5%, then ₹1,500 is charged annually from your investment to cover fund expenses. You don’t pay this amount directly, it’s automatically deducted from the fund’s returns.
 

Major Costs That Add Up to TER in Mutual Funds

Several cost components are included in a mutual fund's total expense ratio. You can determine whether a fund is cost-effective by being aware of what you're paying for. These elements usually consist of,

1. Fund Management Fees:

This is the fee paid to the fund manager and the team responsible for managing your investment, researching stocks, analysing market trends, and making buy/sell decisions.

2. Administrative and Operational Expenses:

These cover day-to-day expenses like office overheads, legal and audit fees, communication charges, compliance costs, and more.

3. Distribution and Marketing Costs:

In regular plans, this includes commissions paid to intermediaries such as brokers, financial advisors, and platforms that help sell the mutual fund.

4. Registrar and Transfer Agent Fees:

These are costs associated with maintaining investor records, handling transactions, and investor servicing.

5. Custodian Charges:

The custodians take the responsibility of keeping the assets of the fund safe. The total expense ratio includes the fees of custodians as well.

All these costs are bundled into the TER and deducted daily from the fund’s assets, reducing the Net Asset Value (NAV) accordingly.
 

SEBI Limit on TER in Mutual Funds

The Securities and Exchange Board of India, as the responsible authority, regulates the maximum total expense ratio that fund houses can charge. These limits depend on the fund’s AUM and vary between equity and debt funds.

Below mentioned are SEBI’s current TER limits for mutual funds:

For equity-oriented mutual funds,

• Assets under Management  up to ₹500 crore – Maximum total expense ratio: 2.25%
• ₹500 to ₹750 crore – Maximum TER: 2.00%
• ₹750 to ₹2,000 crore – Maximum TER: 1.75%
• ₹2,000 to ₹5,000 crore – Maximum TER: 1.60%
• ₹5,000 to ₹10,000 crore – Maximum TER: 1.50%
• Above ₹10,000 crore – TER decreases progressively.

For debt-oriented mutual funds:

• Asset under Management up to ₹500 crore – Maximum total expense ratio: 2.00%
• ₹500 to ₹750 crore – Maximum TER: 1.75%
• Above ₹750 crore – Progressive reduction in TER

In Direct plans of mutual funds, there is no expense of distributor commissions included, and hence they have lower TERs compared to regular plans. If you are comfortable investing without an advisor, direct plans are a cost-effective option.
 

What is Expense Ratio and How is it Calculated?

The expense ratio is calculated as,

Expense Ratio (in Percentage) = (Total Annual Expenses of the Fund / Average Assets Under Management) × 100
Let’s break this down with an example.

Let’s assume a mutual fund has:

• Total annual expenses = ₹15 crore
• Average AUM = ₹1,500 crore

Then, Expense Ratio = (15 / 1500) × 100 = 1.00%

This 1% is deducted from the fund every year, impacting your net returns. The deduction is done daily, which means you never see it directly, but it affects the NAV you receive.

A mutual fund expense ratio calculator can be useful in this situation. It facilitates comparing how various TERs may affect your ultimate returns throughout time.
 

What is the Impact of TER in Mutual Funds on Returns?

Even a small difference in the TER can have a big impact when compounded over several years.

For example, imagine two equity mutual funds:

• Fund A with a TER of 1.5%
• Fund B with a TER of 0.5%

Both generate a gross return of 10% annually. After 10 years, here's what your ₹1,00,000 investment would look like:

• Fund A (net return ~8.5%): ~₹2,26,000
• Fund B (net return ~9.5%): ~₹2,48,000

That’s a difference of more than ₹20,000, just because of a 1% difference in expense ratio which is why it is important concept to understand in finance.

This shows why it’s important to choose mutual funds with competitive TERs, especially for long-term goals like retirement or education planning.
 

Limitations of the Total Expense Ratio in Mutual Funds

TER is an important metric, but it clearly does not show the whole picture. Below are a few of the limitations,

1. It doesn’t Include All Costs:

TER does not include exit loads, securities transaction tax (STT), or other transaction-related charges that may affect your final returns.

2. Low TER ≠ High Returns:

A lower TER doesn’t necessarily mean better performance. An actively managed fund with a slightly higher TER may outperform an index fund with a low TER.

3. Doesn’t Reflect Risk:

The expense ratio doesn't consider how risky or volatile a fund is. So it shouldn’t be the only criteria while selecting a fund.
Use TER as one of several aspects in your decision-making process of choosing to invest in a mutual fund, not the only one.
 

How to Determine a Good Expense Ratio in Mutual Funds?

So, what’s considered a “good” expense ratio? It is dependent on the fund type and your investment strategy.

To determine the best expense ratio in mutual fund options for your portfolio, consider the following,
Compare funds within the same category.

• Check historical performance alongside TER.
• Use tools like a calculator specially designed to calculate the mutual fund expense ratio.
• Consider your investment duration and goals.

A slightly higher TER may be acceptable if the fund consistently outperforms similar category mutual funds.
 

Which Mutual Funds Offer the Lowest Expense Ratios?

If your goal is cost-efficiency, look for funds with a low expense ratio. These are usually,

1. Index Funds:

The base of valuation of such type of funds is a market index and requires less management, resulting in low costs compared to any other type of mutual fund.

2. Exchange-Traded Funds (ETFs):

These funds have the lowest TERs as they are passively managed and traded on the stock exchange.
Investors looking for low-cost exposure to broad market movements often prefer such type of mutual fund, especially for long-term SIPs.
 

Conclusion

The mutual fund expense ratio is more than just a small number buried in fund documents. It has a real and lasting impact on your returns. Understanding TER assists you in making more informed choices, especially when comparing similar mutual funds.

As an investor, always check the TER before investing. Use tools like a mutual fund expense ratio calculator, review your existing mutual fund holdings, and consider switching to lower TER options if they align with your investment goals.

In a world where even 0.5% can mean thousands of rupees over the long term, being mindful of TER is one of the smartest financial decisions you can make.