Should Expense Ratios Affect Your Choice Of Mutual Funds?

When we talk about brokerage charges, we are talking about the commission an intermediary or agent gets or the total fee charged by a mutual fund. For this we need to understand the expense ratio of a mutual fund scheme. 

Every mutual fund scheme charges a fee, called expense ratio. This is expressed in percentage per annum. It is used for administrative, management and all other expenses, including the intermediary expenses or distributors’ commission. How much schemes charge is regulated by the Securities and Exchange Board of India (Sebi). The ratio is normally 1.05-2.25 per cent for equity-oriented mutual funds and 0.07-2 per cent for most other schemes, excluding exchange-traded funds (ETFs), index funds and fund of funds. Debt funds normally have lower expense ratio compared to equity funds; passive funds (index funds and ETFs) lower than active funds; and direct plans are cheaper than regular plans. A regular plan includes distributor commission whereas a direct plan does not. The difference in expense ratio between the two types of plans differs from scheme to scheme. 

Expense ratios very usually depending on the level of involvement of the fund management team. It is for this reason that expense ratios are higher for actively-managed categories such as equity-oriented mutual funds, and lower for, say, direct plans of schemes. 

You can find out the expense ratio for the direct and regular plans for all the schemes in your portfolio and see the difference. You can assume that to be the intermediary commission. Returns are proportionately impacted by expense ratios. 

While expense ratios play a role in the overall cost of your investments, they should not be the only parameter to choose or reject a fund. It will be incorrect to assume that the scheme with the lowest expense ratio will be the best performer. We need to see the objective of the scheme and whether it is suitable to the investor’s risk appetite. Your portfolio returns will depend not on the expense ratio but on selecting the right schemes as per your time horizon and risk-taking capacity, and by monitoring your portfolio regularly. The role of expense ratios is very limited in the overall wealth building exercise.

The author is a certified financial planner with Handholding Financials

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