Mutual funds are one of the most common investment options in India. When you invest in mutual funds, you rely on professional fund managers. But did you know that managing any fund incurs certain expenses? Who bears these expenses? You do. As an investor, you have to pay a fee known as the Total Expense Ratio (TER). When it comes to investing, every penny counts. You must understand everything about this silent return-eroding factor: the Total Expense Ratio (TER).
Let’s understand the Total Expense Ratio and see why it is important for every investor!
Total Expense Ratio (TER)
The Total Expense Ratio (TER) shows the yearly cost of managing a mutual fund as a percentage of the fund’s total assets.
- These expenses include administration, management, and advertising costs.
- A 1% expense ratio means 1% of the fund’s total assets to be used for expenses each year.
- In India, the expense ratio is flexible within prescribed limits.
- Regulation 52 of SEBI (Mutual Funds) Regulations, 1996, specifies these limits.
- A higher TER means higher costs, which can reduce your returns.
In simple terms, TER tells you how much of your money goes to fund management expenses each year.
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TER in Mutal Funds- SEBI Limit
Effective from April 1, 2020, the revised TER limits are as follows:
Assets Under Management (AUM) – Maximum TER as a percentage of daily net assets:
For Equity Funds
- First Rs. 500 crores: 2.25%
- Next Rs. 250 crores: 2.00%
- Next Rs. 1,250 crores: 1.75%
- Next Rs. 3,000 crores: 1.60%
- Next Rs. 5,000 crores: 1.50%
- Next Rs. 40,000 crores: 0.05% reduction for every Rs. 5,000 crore increase in daily net assets
- Above Rs. 50,000 crores: 1.05%
For Debt Funds
- First Rs. 500 crores: 2.00%
- Next Rs. 250 crores: 1.75%
- Next Rs. 1,250 crores: 1.50%
- Next Rs. 3,000 crores: 1.35%
- Next Rs. 5,000 crores: 1.25%
- Next Rs. 40,000 crores: 0.05% reduction for every Rs. 5,000 crore increase in daily net assets
- Above Rs. 50,000 crores: 0.80%
TER in mutual funds directly affects a scheme’s NAV; lower TER means higher NAV.
Thus, TER is crucial when selecting a mutual fund scheme.
Current SEBI regulations require mutual funds to disclose the TER of all schemes daily on their websites and the AMFI website.
What are the Costs Involved in the Total Expense Ratio?
The costs involved in the Total Expense Ratio (TER) for mutual funds in India typically include:
- Fund Management Fees: Fund managers receive a fee for managing the fund’s portfolio, usually ranging from 0.5% to 1% of the fund’s assets.
- Administrative Expenses: These cover day-to-day operations like record-keeping and customer service.
- 12b-1 Distribution Fees: These include marketing, distribution, advertising and compensation for financial advisors.
- Brokerage Charges– This is the fee that you pay to your online trading platform for investing in mutual funds.
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5. Other Operating Charges: This may include custodian fees, registrar fees, and other miscellaneous expenses related to fund operations.
Total Expense Ratio Formula and Calculation
To calculate the Total Expense Ratio (TER), divide the total expenses for managing the fund by the fund’s total assets.
The total expense ratio formula is:
TER= (Total Fund Assets/Total Expenses)×100
- Total Expenses: This includes administration costs, audit fees, transaction costs, legal and accounting fees, sales, and marketing expenses, among others.
- Total Fund Assets: This is the market value of all the stocks, bonds, and other investments held by the fund at a given time.
This formula helps determine the percentage of the fund’s assets used for operational costs, providing a clear picture of the fund’s efficiency.
Working of Total Expense Ratio (TER)
As an investor, you must closely watch the Total Expense Ratio (TER) because it directly impacts your returns.
For instance, if a fund earns 5% in a year but carries a TER of 3%, the actual gain declines to roughly 2%.
The TER simplifies the annual operational costs of a fund into one figure, usually a percentage. The fund’s assets serve as the base for calculating this figure.Therefore, the TER changes depending on the fund’s performance.
Actively managed funds have higher TERs due to increased personnel costs and transaction fees. Whenever a buy or sell trade occurs, the fund manager incurs brokerage fees.
On the other hand, passive funds have lower operating costs, resulting in a lower TER.
What is a Good TER in Mutual Fund?
A good TER in a mutual fund depends on the type of fund and the investment strategy. Generally, lower TERs are better because they leave more money invested to grow over time.
- Equity Funds: These funds usually have higher TERs because they require active management and more research.
A TER of 1.5% to 2.5% may be reasonable. - Debt Funds: These funds often have lower TERs since they involve less active management.
A TER of 0.5% to 1.5% is typical. - Index Funds: These funds passively track a market index and have the lowest TERs, usually ranging from 0.1% to 0.5%.
When choosing a mutual fund, you must compare the total expense ratio of similar funds.
Importance of Total Expense Ratio For Traders and Investors
Traders and investors should know about the Total Expense Ratio (TER) for several reasons:
- TER shows the costs of an investment fund, ensuring transparency and informed decisions.
- It helps evaluate a fund’s real performance since a high TER can reduce returns.
- TER is crucial for comparing different funds to see which offers better value for management costs.
- Understanding TER aids in accurately forecasting potential returns and aligning them with investment goals.
- Over time, even a small TER difference can significantly impact overall investment growth.
By understanding TER, traders and investors can choose funds wisely, avoiding excessive fees and maximizing their investment potential.
Conclusion
Understanding the Total Expense Ratio is crucial for anyone investing in mutual funds. It helps you estimate the cost-effectiveness of their investment options. Lower TERs are generally better, but it’s also important to consider the potential for higher returns that might justify higher expenses.
FAQs| Total Expense Ratio
The Total Expense Ratio (TER) covers all the costs to run a mutual fund, shown as a percentage of the fund’s daily net assets. In India, TER is flexible but must follow SEBI’s regulatory limits.
Yes, the Total Expense Ratio (TER) is deducted daily from the fund’s assets.
Yes, TER directly impacts the Net Asset Value (NAV) of a fund, as it is deducted from the fund’s assets, affecting the overall returns.
A lower TER is usually better. It differs by fund type, with equity funds typically ranging from 1.05% to 2.25% and debt funds from 0.8% to 2%.
Source-amfiindia.com
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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.