How To Gauge If Your Mutual Fund’s Expense Ratio Is Optimum

Mutual funds charge a fee known as expense ratio to cover their costs. The fee covers expenses such as operating costs, management fees, advertising costs, registrar fees, administrative expenses, audit fees and asset allocation charges, among others. 

That said, sometimes, mutual funds charge higher expense ratios for the same category of funds. That’s why it becomes important to find the right fund with the lowest expense ratio, which can also meet your return goals. 

The Securities and Exchange Board of India (Sebi) has set an upper limit on the total expense ratio (TER). The Sebi Mutual Fund Regulation specifies the permissible limits of TER that can be charged by a mutual fund asset management company (AMC). The highest TER is set at 2.25 per cent for equity mutual funds which have less than Rs 500 crore worth of assets under management (AUM).

Mutual funds with low AUM can have high TER, and funds with higher AUM, are capped at a low expense ratio. 

Therefore, going for a fund with a larger AUM can decrease the amount you spend on acquiring net asset value (NAV) of the units. 

The expense ratio might seem like a small amount, but in the long run, these charges will impact your redemption amount. Moreover, with a lower expense ratio, you get more units, too. 

Mutual Funds With Lowest Expense Ratios

Passive mutual funds have the lowest expense ratios. These are mutual funds, which are based on a particular index. Exchange-traded funds (ETFs), fund of funds (FOFs) and some factor-based funds come under this category. 

In October 2022, index funds and ETFs (except gold) gathered Rs 9,920.44 crore in investment from retail investors. These funds have the lowest expense ratio, as these funds are just following an Index and not actively picking stocks. 

That said, one can build a diversified portfolio with the help of passive funds. 

One can invest in index funds if one is a long-term investor looking for a low expense ratio. 

If you do not want to invest in plain index funds, you can invest in factor-based funds, as well. Some of these factor funds are based on certain National Stock Exchange (NSE) indices, such as Nifty Momentum and Nifty Value.

Hence, these factors can be used to pick valuable or momentum stocks without paying high expense ratios. Some fund houses also have their own factor-based investing products, such as low volatility funds, but these products have a little higher expense ratio.

Impact Of Expense Ratio

These charges are deducted from the fund house’s revenue before it is distributed to the investors. As this has a direct relationship with the return earned, it is critical to properly examine the mutual funds before investing. 

For example, let’s assume you have put Rs. 10,000 in a fund with a 1 per cent expense ratio. It implies that you must pay Rs. 100 to the fund house to manage your investments.