How does expense ratio determine a mutual fund’s returns?

When the question of what is expense ratio in mutual fund arises, the answer to this lies in the basic understanding of mutual funds. For every mutual fund, it takes a fund manager who operates the fund. The expense ratio is the fees charged to investors to cover the operating expenses. It is calculated as a percentage of total assets and is paid to the manager (i.e. AMC) as the maintenance fee. The manager has an expert team to aid in the management of the funds. The function of this team is to analyze, allocate, manage and advertise so that the funds provide maximum returns with minimum risk to the investors.

Expense ratios are listed on the prospectus of every fund and also on many financial websites. The expense ratio is considered as a single fee or charge by many individuals and investors but in reality, it is a combination of various charges for managing the plan. This cost is retrieved from the mutual fund investors daily but they are only revealed at one time in six months to the investors. This is what is expense ratio in mutual fund actually is. 

What does the expense ratio cover?

It is always best to answer the question of what is expense ratio in mutual fund is with the help of describing what it consists of. There are majorly four components included in the expense ratio:

1. Management fees

The management fees or investment advisory fee is the compensation of a manager’s expertise. The average management fee is up to 1% of the fund assets. 

2. Distribution fees

Usually, this fee is charged by the mutual fund companies for promotion and advertisement. 

3. Administrative fees

This fee is charged for running the funds. This includes providing customer services, keeping records, information emails, and other communication processes.  

4. Brokerage fees

The investment transaction is processed either by the Asset management company or through the broker, hence this fee. 

Thus, these components give a clear picture of the expense ratio. If you wish to know more in detail about what is expense ratio in mutual fund is and its impact on an investor, you can visit https://navi.com/blog/what-is-expense-ratio/ for more information. 

How expense ratio determines your mutual fund returns?

Now that it is understood what is expense ratio in mutual fund is, it is necessary to understand how it impacts the returns on a mutual fund:

  • Returns on mutual funds for small investors

The expense ratio is directly connected with the returns on mutual funds. If the funds invested in assets are high the expense ratio can be low and vice-versa. Similarly, if the expense ratio is high then there is a decrease in returns of the investors and if the expense ratio is low then it adds more returns to the investors. For example, If you invest INR 40000 in a mutual fund, and INR 1,000 is the expense if the expense ratio is 2.5%. If there are 10% returns then the net earnings will be only 7.5%. On the contrary, if the expense ratio is 1% then the gain would be 9% returns on total investment. 

  • Returns for high net worth investors

In a market there are small investors as well as high net worth investors, so that expense ratio creates a huge impact on them. For example, if any high net worth investor invests INR 1,00,00,000 with an expense ratio of 1%, then the expense would be INR 1,00,000. However, if the expense ratio increases to 2% then the amount is INR 2,00,000. Thus, an increase in the 1% expense ratio affects the investor’s return by INR 1,00,000. 

Since the investor’s net returns are revealed after deducting the fees and thus an investor needs to know how much the company is charging as an expense. Therefore, apart from understanding what is expense ratio in mutual fund, it is essential to understand how the expense ratio determines the mutual fund returns to be a successful investor. 

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