# What is Expense Ratio ! Calculation – Complete Information

If you are investing in Mutual Funds or are thinking of investing, then you must be aware of Expense Ratio. Today we will understand what is Expense Ratio and how Expense Ratio is calculated. ## What is Expense Ratio in Mutual Funds

As you know that a mutual fund is made up of deposits of many investors. For when and where to invest your deposits, there is a fund manager to manage it. This fund manager is appointed by the Fund House (AMC).

Here Expense Ratio is the fee charged from you for the expenses of this fund manager and fund house. It simply means that the mutual fund house is charging some fee from the investor for its services.

There are many charges involved in the Mutual Fund Expense Ratio, which are as follows-

• Fund Management Expenses
• Distribution Commission
• Registration Fee
• Legal & Audit Expenses

Expense Ratio Meaning- Let us try to understand Expense Ratio in a little more simple language. Expense Ratio is also called Total Expense Ratio (TER). Total Expense Ratio is what you pay to manage your invested amount in a year.

If you have invested Rs 10,000 in any mutual fund and the Expenses Ratio of this scheme is 1.5%. In this case, you are paying an expense ratio of Rs 150 for a year to manage your money.

Similarly, if you do SIP, then the expense ratio is payable on your current portfolio.

## How is Expenses Ratio recovered?

This question must be coming in your mind that how do fund houses charge you Expense Ratio. You must have noticed that if you have invested Rs 1,000 in Mutual Funds, then the entire Rs 1,000 units are allotted to you by the AMC.

Mutual fund houses charge you the Expense Ratio from your returns. The NAV of any mutual fund is drawn at the end of daily trading day. These NAVs are calculated on the basis of the performance of the mutual fund’s portfolio throughout the day.

Expense ratio is deducted even before the final NAV is calculated. Thus the expense ratio is deducted directly from your returns.

## How is Expense Ratio Calculation done? Expense Ratio is indicated as a percentage which is annual. But it is calculated on the basis of one day only.

That means, it is cut every day. If the Expense Ratio of your Mutual Fund is 1%, then your Expense Ratio for one day will be = 1% ÷ 365 days

Through this table you can easily understand it.

If Arun has invested Rs 1 lakh in a mutual fund scheme on March 1 and its expenses ratio is 1%.

 Date Current Investment Value (A) Expense Ratio (B) Net Portfolio value (A-B) 02 March Rs 1,00,500 (1% × 1,00,500) ÷ 365  = 2.75 Per Day Rs 1,00,497.25 03 March Rs 1,03,000 (1% × 1,03,000) ÷ 365  = 2.82 Per Day Rs 1,02,997.18

If his mutual fund portfolio is giving an annual return of 15% and your fund’s expense ratio is 2%. In this situation the net return of your fund will be only 13%.

## Do you have to pay Expense Ratio even on negative returns?

Positive return or negative return has nothing to do with expense ratio. As you read above, Expense Ratio is taken by the fund house to manage your fund. So your portfolio is giving negative returns even then you will be charged Expense Ratio by the fund house.

If Varun has invested Rs 1 lakh in a mutual fund scheme on 1st March and its expenses ratio is 1%.

 Date Current Investment Value (A) Expense Ratio (B) Net Portfolio value (A-B) 02 March Rs 99,000 (1% × 99,000) ÷ 365  = 2.71 Per Day Rs 98,997.29 03 March Rs 97,000 (1% × 97,000) ÷ 365  = 2.66 Per Day Rs 96,997.34

If his Mutual Fund is giving a negative annual return of 10% and the Expense Ratio of your fund is 2%. In this case the net return of your fund will be negative 12%.

## Difference between Expense Ratio of Direct Plan and Regular Plan

There is no difference between direct plan and regular plan of any mutual fund, except the expense ratio. The expense ratio of a regular plan is always higher than that of a direct plan.

Due to the commission of the distribution agent in the regular plan, the expense ratio remains high.

## Effect of Expense Ratio on Returns

In the case of equity funds, the expense ratio does not matter as much as it does in debt funds. Therefore, always choose Debts Funds whose Expense Ratio is the least.

The lower the Expense Ratio, the higher will be the returns. Expense ratio has a great impact on returns in the long run. As an investor, there is not much you can do in terms of expense ratio.

But if you invest in a direct plan instead of a regular plan, your returns can be much higher than the regular plan in the long term. Therefore, while choosing a mutual fund, keep in mind the Expense Ratio.

## Should we not invest in Mutual Funds with high Expense Ratio?

It would not be fair to say that we should not invest in the fund whose Expense Ratio is high.

If the Expense Ratio of a fund is high then it may be an aggressively managed fund with high potential to give returns.

Therefore, while selecting a mutual fund, all the parameters should be taken care of, in which returns are the most important.

## Expense Ratio Limit by SEBI

In order to protect the interests of investors, SEBI has imposed certain limits on charging Expense Ratio on Mutual Fund companies under Regulation 52.

Fund houses have to keep the expense ratio within this limit imposed by SEBI.

Maximum Total Expenses Ratio

 AUM Slab Equity Oriented Schemes Other Schemes (Other than ETFs and Index Funds) 0-500 Cr. 2.25% 2.00% 500-750 Cr. 2.00% 1.75% 750-2000 Cr. 1.75% 1.50% 2000-5000 Cr. 1.60% 1.35% 5000-10000 Cr. 1.50% 1.25% 10000-50000 Cr. Decreasing TER by 0.05% for every 5000 crore or part thereof increasing AUM Decreasing TER by 0.05% for every 5000 crore or part thereof increasing AUM 50000 Cr. more than 1.05% 0.80%

Other Schemes (Source – SEBI Press Release)

 Type of scheme Maximum Total Expenses Ratio Equity-oriented close-ended or interval schemes 1.25% Other than equity-oriented close-ended or interval schemes 1.00% Index Funds / Exchange Traded Funds (ETFs) 1.00% Fund of Funds investing in actively managed Equity-oriented schemes 2.25% Fund of Funds investing in actively managed other than Equity-oriented schemes 2.00% Fund of Funds investing in liquid, Index and ETFs 1.00%

From the first table given above, you must have understood that as the AUM (Asset under Management) of the fund increases, the Expense Ratio of the fund decreases.

## Relationship of AUM and Expenses Ratio

If a fund has been launched recently and its AUM is less then its Expenses Ratio will be high. As the AUM increases, the Expenses Ratio decreases.

#### Case- 1

• Fund’s Total Assets or AUM = Rs 5 Crore
• Administrative Expenses = Rs 5 Lakh
• Other expenses = Rs 1 Lakh

Expense Ratio Formula- Here TER (Total Expense Ratio) will be = Total Expenses / Total Asset

6 Lakh ÷ 5 Crore = 1.20%

#### Case- 2

• Fund’s Total Assets or AUM = Rs 10 Crore
• Administrative Expenses = Rs 5 Lakh
• Other expenses = Rs 1 Lakh

Expense Ratio Formula- Here TER (Total Expense Ratio) will be = Total Expenses / Total Asset

6 Lakh ÷ 10 Crore = 0.60%

Here in Case 1 the AUM was only 5 crores so the expense ratio was coming to 1.20%. But when the AUM here increased to 10 crores in Case 2, the same expense ratio came down to 0.60%.

## Conclusion

If seen, Expense Ratio is very important, but Expense Ratio is not the only parameter for choosing a Mutual Fund. Therefore, always invest in the right way and only after thorough research.