Do you know how Mutual Funds recover their Expenses?

Have you ever given a thought how Mutual Funds recover their Expenses?

Do they recover it from you before they declare the NAVs of the respective schemes? Are the returns you receive from your mutual funds investments is the net of expenses incurred by them while managing the funds?

What is Mutual Fund Expense Ratio?

A Mutual fund incurs expenses like fund management fee, agent commissions, registrar fees, and selling & promoting expenses. Now you know that Mutual Funds incur expenses while managing your funds, the next question in your mind could be how much. This leads to the concept of mutual fund expense ratio.

‘Mutual Fund Expense ratio’ is nothing but the recurring cost per unit- incurred to operate a scheme – and is charged to your assets. Such mutual fund expense ratio is calculated periodically but is charged daily on the NAV. This annual recurring expenses is disclosed every March and September and is expressed as a percentage of the fund’s average weekly net assets.

How Mutual Fund Expense Ratio Impacts Your Returns?

Mutual Fund Expense ratio helps you to know how much you pay a fund every year to manage your investment. In case you have invested Rs1,00,000 in a MF, whose mutual fund expense ratio is 1.8%, you are paying Rs1,800 every year to manage your investment. That is, if MF is earning, say, 15%, your return would be 13.2%. The NAV’s are declared net of expenses. It is therefore important for you to know what the expense ratio of a mutual fund is.

A higher mutual fund expense ratio will mean lower return for you and vice versa.

SEBI’s Regulation on Mutual Fund Expense Ratio:

Different Mutual Funds have different expense ratio, and to regulate this SEBI has put a cap that a mutual fund can charge, which are:

SEBI also provided a recent option for investors to buy funds directly from MFs (not through the distributor). If bought directly, the NAV, called the direct plan NAV, will not bear the fee paid to distributor. That means the direct plan NAV will be higher than the regular NAV to that extent. This way, you may increase your returns on your MF investment.

Should Mutual Fund Expense Ratio matter to you?

In competitive developed countries market it does matter because returns are often in single digits, the mutual fund expense ratio can cause a dent in the amount you can take home. But in markets such as India, where equity funds have comfortably managed double digit returns, mutual fund expense ratio has not really mattered much, especially in equity funds.

For instance, the average return of equity funds over the last 10 years was 23 per cent annually. This return, which is post expenses, is good enough. You may select a reasonably performing mutual fund and may ignore the mutual fund expense ratio.

But in case of a debt fund, mutual fund expense ratio matters. Mutual fund expense ratio plays a crucial role selecting a debt fund to invest.

Where to find the Mutual Fund Expense Ratio?

Whenever, you may think of investing in a new fund offer, you have to go through the offer document section called ‘Fees and expenses of the scheme’. This will give you the maximum expense ratio that a mutual fund can incur.

For an existing scheme, you can look at monthly fact sheet or the Key information Memorandum for the recurring scheme expense.

Mutual Fund Expense Ratio and Tenure of the Investment:

Again, if you are looking at 6 months or 1-2 yrs investment scenario, mutual fund expense ratio will not matter much, you can probably just avoid it, but if you are looking from a long-term investment like 5-10-20 yrs.

In that case, you have to know about the history of the mutual fund expense ratio and follow its likely projections and performance.

Also, you have to keep it mind that a lower mutual fund expense ratio does not always lead to a better-managed fund. The fact is a good fund is one that delivers good return with minimal expenses.

The author is Ramalingam.K an MBA (Finance) and certified financial planner. He is the Director & Chief Financial Planner of holistic investment planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He Can be reached at ramalingam@holisticinvestment.in