1. What is expense ratio?
Every mutual fund automatically deducts a small fraction of your investment value daily as an expense ratio or fees to cover its costs. These costs include expenses for fund management, advertising, marketing, administration, and for paying sales commissions to distributors. This fraction of your investment value that is deducted is called the expense ratio and it is usually expressed as a percent per annum .The expense ratio is a measure of the per unit cost incurred in managing a fund. The fund house calculates it by dividing the fund’s total expenses by its assets under management.
2. What are the expenses a fund house incurs?
Fund houses employ research analysts and fund managers who are highly qualified and experienced professionals. They track developments in equity, debt and money markets and build portfolios for schemes that they manage in line with the fund’s offer documents. In addition there are sales teams, and other team members who are paid salaries and performance incentives. Every scheme incurs operating expenses such as fee for transfer and registrar agents. They are responsible for issuing and redeeming units of the mutual fund and providing other related services. Then there is custodian fee paid for holding and safeguarding the securities. In addition there are legal expenses, audit fees, as well as marketing and distribution expenses.
3. How is the cost recovered from investors?
A mutual fund recovers the cost incurred by it from its unit holders on a daily basis. The daily net asset values (NAVs) of a fund scheme are reported after deducting such expenses. The expense ratio is disclosed in the fact sheet of the scheme every month. This percentage fee is levied on your entire investment’s value. For example, If you have invested ₹10,000 today in a fund with an expense ratio of 2%. At the end of the day, the mutual fund deducts approximately 50 paise from your portfolio and your investment value at the end of the day becomes ₹9,999.5. Now, let’s say your investment value goes up by 2% up from ₹9,999.5 to ₹10,200 tomorrow. Again, at the end of the day tomorrow, approximately 51 paise is deducted from your portfolio and your investment value at the end of tomorrow is ₹10,199.49.
4. Why is the expense ratio of a direct plan lower than that of a regular plan?
Expenses for a regular plan include distribution costs in addition to the operating costs. Direct plans bypass distributors and hence the expense ratio for a regular plan will always be greater than that for a direct plan.