In order to maximize your potential returns, expense ratio comparison becomes a critical factor while comparing mutual funds, index funds or exchange traded funds (ETF).
When you invest your money in mutual funds or ETF, these funds deduct some amount of money for managing the mutual fund and handling operating costs and expenses.
Although, these fees cannot be avoided completely, you can look for lowest expense ratio mutual funds which are cost effective and give higher returns to investors.
Debt mutual funds, index funds and ETF are considered as low expense ratio mutual funds when you compare the average expense ratios of equity mutual funds, debt mutual funds and hybrid mutual funds.
What Is A Good Expense Ratio For A Mutual Fund?
What is a reasonable or good expense ratio for a mutual fund? Generally, an expense ratio in the range of 0.5% to 0.75% is considered to be a good, low expense ratio for a mutual fund that is actively managed.
Expense ratio greater than 1.5% is considered to be on the higher side. However, these numbers can be different for index funds, exchange traded funds or debt mutual funds.
Using an expense ratio as a parameter to compare different mutual funds and ETF and then choosing a low expense ratio mutual fund can be a great way to ensure that you are getting best returns on your investments.
If you compare the expense ratios of direct and regular mutual funds, you will notice that direct mutual funds have lower expense ratio than regular mutual funds as they don’t include the fees or commissions paid to intermediaries.
Passively managed mutual funds have lower expense ratio when compared to actively managed mutual funds as they don’t have any team of analysts making active investment decisions.
Mutual funds with smaller AUM (assets under management) have higher expense ratios as they have to meet all the expenses from smaller asset base. Higher the AUM, lower is the expense ratio of the fund with similar investment strategy.
Expense Ratio Meaning
By definition, expense ratio is the percentage of total assets which mutual fund companies charge to the investors every fiscal year to cover mutual fund operating expenses. These expenses include:
- Asset Management Fees
- Administrative Fees
- Marketing Fees
- Advertising Fees
- Legal Fees
- Registrar Fees
- Trading Charges
- Operating Costs
- Other Fixed Overhead Costs
Expense Ratio Calculation
For example, if you are investing in a mutual fund which has a management expense ratio of 1%, then for every $1000 of your investment, the fund will deduct $10 each year.
This $10 deduction is not seen in your statement and you won’t get any bill for this charge. This reduction is reflected in the form of lower net asset value for the fund shares.
Expense Ratio Formula
How can you calculate expense ratio? Either you can use online expense ratio calculator or you can use this formula to calculate expense ratio of a mutual fund.
Total Expense Ratio = Total Fund Costs / Total Fund Assets
From the above formula we can see that there are two ways in which a mutual fund manager can reduce the expense ratio of a fund. Either he can increase the revenues or he can decrease the expenses.
Expense Ratio Example
How does a higher expense ratio impact your fund returns in next 10, 20 or 30 years? How much would you earn if you invested in a zero expense ratio mutual fund? Check out the table below to see how your initial investment of $1000 grows with an annual fund return of 12%.
|TER||10 Yrs||20 Yrs||30 Yrs|
Total Expense Ratio
Total Expense Ratio (TER) of a mutual fund or ETF indicates how much percentage of your investment you would be paying for the various expenses associated with managing a mutual fund. These expenses include:
- Fund Distribution Charges
- Investment Advisory Services
- Accounting Fees
- Legal Costs
- Custodial Costs
- Transfer Agency Costs
- Shareholder Reporting Expenses
- Back Office Expenses
Gross Expense Ratio
Gross expense ratio measures the percentage of total assets required to manage the fund before any reimbursements or fee waivers. Gross expense ratios on ETF and mutual funds do not include any brokerage charges or fund sales charges.
Net Expense Ratio
Net expense ratio indicates what the investors would be charged ultimately after any reimbursements or fee waivers. Net expense ratio of a mutual fund or ETF is also known as audited ratio.
Mutual Fund Charges
In addition to expense ratio, there are various other charges which might be deducted by mutual fund companies. Below are few of them.
- Management Fees
- Administrative Fees
- Distribution Fees
- Entry Load
- Exit Load
- Transfer Fees
Mutual funds charge management fees or investment advisory fees as a compensation to fund managers who use their fund management experience to develop best investment strategies.
Administrative expenses like customer service and support, record and book keeping, information emails, etc are covered under administrative costs.
Distribution fee is used for various advertising channels, marketing campaigns and other promotional purposes to promote the fund to investors.
Entry load is paid by an investor when he purchases mutual fund units. It is usually calculated as a percentage of total investment.
Exit load is charged when an investor redeems mutual fund units or decides for an early withdrawal before pre-defined lock-in period.
Transfer fee or switch fee is charged whenever an investor decides to transfer his investment from one mutual fund scheme to another under same mutual fund company.
Regular vs Direct Mutual Funds
Regular plans are mutual funds which you buy from an intermediary like distributor or agent or broker. These intermediaries charge commission or distribution fees for the service they provide which increases the expenditure of your initial investment.
Direct plans are mutual funds which you can buy directly from Asset Management Companies (AMC). There are no intermediaries involved and they do not charge any distribution fees or commissions.
Regular mutual funds are more convenient as they save your time spent on research and analysis. You can also get expert guidance from financially qualified agent or distributor.
Direct mutual funds will give you higher potential returns as they have lower expense ratios because investors can buy the plans directly from mutual fund companies without involving any intermediary.
Regular mutual funds will give you lower returns as they have higher expense ratios due to the fees and commissions charged by agents and distributors.
Direct mutual funds are less convenient and they are suitable for those who can do their own research and take their own decision without any financial advice or guidance.
The below table illustrates the advantages and disadvantages of investing in direct or regular plans of mutual funds.
|Research||By Expert||By Self|
Active vs Passive Mutual Funds
The goal of active portfolio management strategy is to beat the benchmark index by taking advantage of the short term price fluctuations of a stock, bond or any other underlying asset.
Passive mutual funds do not require any hands-on management as they follow passive portfolio management strategy by investing in stocks which are part of an underlying index.
Index funds are a good example of passive mutual funds. The performance of passive funds is very close to the performance of benchmark index.
Pros & Cons
Active mutual funds have higher expense ratios as there is an active management team involved in making investment decisions. But there is a possibility of active funds beating the benchmark and giving higher returns to investors.
On the other hand, passive mutual funds have lower expense ratios as there is no active decision making involved. But their returns are similar to the benchmark index and they miss out the potential for out-performance.
Expense Ratio Comparison
A lower expense ratio means more profitability and a higher expense ratio means less profitability. Hence, expense ratio comparison becomes a critical factor. But when you are comparing expense ratios, be sure you are comparing mutual funds with same type and same investment objective.
Expense ratios are just one of the many fees that investors pay. But you should also look at other costs that can hurt your portfolio returns, such as mutual fund sales loads or administrative fees or transfer fees.
Lowest Expense Ratio Mutual Funds
In general, debt mutual funds have lower expense ratios than equity mutual funds or hybrid mutual funds. Below is the list of different types of debt mutual funds.
- Overnight Funds
- Liquid Funds
- Money Market Funds
- Floating Rate Debt Funds
- Ultra Short Term Debt Funds
- Short Term Debt Funds
- Intermediate Term Debt Funds
- Long Term Debt Funds
- Dynamic Debt Funds
- Corporate Debt Funds
- Government Debt Funds
- Municipal Debt Funds
- Credit Risk Funds
- Fixed Maturity Plans
- Junk Debt Funds
- International Debt Funds
- Tactical Debt Funds
- Tax Free Debt Funds
- Inflation Protected Debt Funds
- Unconstrained Debt Fund
- Convertible Debt Funds
- Inverse Debt Funds
- Diversified Debt Funds
- Leveraged Debt Funds
Highest Expense Ratio Mutual Funds
In general, equity mutual funds have higher expense ratios than debt mutual funds or hybrid mutual funds. Below is the list of different types of equity mutual funds.
- Large Cap Equity Funds
- Mid Cap Equity Funds
- Small Cap Equity Funds
- Index Funds
- Exchange Traded Funds (ETF)
- International Equity Funds
- Global Equity Funds
- Domestic Equity Funds
- Emerging Market Equity Funds
- Commodity Equity Funds
- Preferred Equity Funds
- Total Equity Funds
- Market Neutral Equity Funds
- Long Short Equity Funds
- Sector Funds
- Value Funds
- Growth Equity Funds
- Diversified Equity Funds
- Dividend Equity Funds
Moderate Expense Ratio Mutual Funds
In general, hybrid mutual funds have expense ratios in between debt mutual funds and equity mutual funds. Below is the list of different types of hybrid mutual funds.
- Aggressive Funds
- Conservative Funds
- Equity Savings Funds
- Fixed Income Funds
- Arbitrage Funds
- Dynamic Asset Allocation Funds
- Multi Asset Allocation Funds
- Gold Mutual Funds
- Silver Mutual Funds
- Target Date Funds
- Alternative Funds
- Fund Of Funds