As you know, every investment you make involves a cost; there are no free lunches.
When investing in mutual funds too, there is a cost involved. This cost is called the expense ratio.
As an investor, you cannot afford to ignore the cost of investing as it weighs down on your returns.
What is Expense Ratio?
To run a mutual fund house, there are several costs involved.
These are investment management fees, brokerage on buying and selling securities, registrar & transfer fees, custodian fees, legal fees, audit fees, sales & marketing /advertising expenses, administrative expenses, and so on.
These costs are encapsulated into a Total Expense Ratio (TER), which is charged or levied by the fund house on you, the investor, in the respective mutual fund scheme.
The TER is charged to the Net Asset Value (NAV) of a mutual fund scheme.
The TER is expressed as an annual percentage of the fund’s net assets and is adjusted daily from the NAV, which mutual funds must disclose after accounting for this cost.”
How is TER Calculated?
TER = (Total Expense of the Scheme during the period / Total Scheme Assets) x 100
As per the regulatory guidelines, there are defined maximum limits for types of mutual fund schemes (equity-oriented and debt-oriented), and depending on whether the scheme is actively managed or passively managed.
It is important to note that the TER is fungible. Meaning, that there is no limit on any particular type of allowed expense as long as the TER is within the prescribed limit.
Within the respective category and sub-category, the TER varies among the peers.
In addition, the expense ratio differs between a mutual fund scheme under the Regular Plan and a Direct Plan. When you transact through intermediaries, the ‘Regular Plan’ is usually used wherein the expense ratio is higher to incentivise the intermediary.
In the case of ‘Direct Plan’, you purchase units directly from the asset management company or through mutual fund platforms encouraging Direct plans. Thus, the expense ratio is lower than in the case of the Regular Plan.
Here are the Top 5 Equity Mutual Funds with Low Expense Ratio in India
Equity MF Schemes With Low Expense Ratios
| Scheme Name | Expense Ratio | AUM (Rs crore) | |
| Direct plan | Regular Plan | ||
| Parag Parikh Flexi Cap Fund | 0.62 | 1.27 | 98,541 |
| HDFC Flexi Cap Fund | 0.81 | 1.41 | 74,105 |
| HDFC Mid-Cap Opportunities Fund | 0.89 | 1.42 | 74,910 |
| ICICI Pru Bluechip Fund | 0.85 | 1.43 | 68,034 |
| Kotak Emerging Equity Fund | 0.44 | 1.44 | 49,646 |
The securities quoted are for illustration only and are not recommendatory. It is as per schemes having a low expense ratio.
The list is not exhaustive.
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
Source: ACE MF
The schemes mentioned here are among the actively managed equity mutual fund schemes from sub-categories such as flexi cap funds, mid cap funds, and large cap funds.
Should You Base Your Investment Decision Solely on the TER?
Certainly not.
The expense ratio is important but should not be the deciding factor in picking the best mutual fund schemes.
It is important to compare the expense ratio of a fund with the other schemes within the same category and sub-category.
But sadly, what most people search for on Google is “mutual funds with low expense ratio” and make their investment decisions.
Ideally, other than the expense ratio, check for the following to make the best choice:
- Returns over various time frames (6-months, 1-year, 2-year, 3-year, 5-year, 10-year, since inception)
- Performance across market phases (i.e., bull and bear phases)
- Risk ratios (Standard Deviation, Sharpe, Sortino, etc.)
- The expense ratio of the scheme
- Portfolio characteristics. These are the top-10 holdings, top-5 sectors, how concentrated/diversified is the portfolio, the market capitalisation bias, and the portfolio turnover.
- The style of investing– value, growth, or blend. In the case of debt funds, these are the average maturity, modified duration, and quality of debt papers.
- The quality of the fund management team, i.e., the experience of the fund manager, the number of schemes managed, the track record of the schemes under, the experience of the research team, etc.
- The overall efficiency of the mutual fund house in managing investors’ hard-earned money, i.e., the proportion of AUM actually performing.
- The investment processes & systems followed at the mutual fund house.
Why it makes sense to opt for the Direct Plan
Direct Plans help keep the cost of investing low.
As mentioned before, the expense ratio under the Direct Plan is less than the Regular Plan. This is because mutual fund houses do not have to pay commissions to distributors under the Direct Plan.
Currently, the difference in the expense ratio under the Direct Plan and Regular Plan of actively managed equity mutual funds ranges between 0.3% to 2.6%, with an average difference of about 1.2%.
Now, while the difference may not seem much, it does impact the overall returns or corpus you would build over the long term.
Corpus Built Over the Years Under the Direct Plan and Regular Plan
| Direct Plan | Regular Plan with 0.5% higher Exp. Ratio | Regular Plan with 1% higher Exp. Ratio | |
| Amount invested (in Rs) | 1,000,000 | 1,000,000 | 1,000,000 |
| Value after 30 years (in Rs) | 29,959,922 | 26,196,666 | 22,892,297 |
| Difference (in Rs) | 3,763,256 | 7,067,626 |
For illustration purposes only
Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
The table above demonstrates how an apparently small difference of 0.5% and 1% in the expense ratio of a mutual fund scheme can weigh on the corpus built at the end of the investment tenure.
In the case above, after 30 years, the corpus built under the Direct Plan would have been Rs 2.99 crore, noticeably higher than under the Regular Plan (assuming a CAGR of 12% p.a.).
In other words, a higher expense ratio charged by the fund does eat into the returns and corpus you make.
If you can build a mutual fund portfolio on your own and monitor it (including reviewing and rebalancing when needed), ideally, it makes sense to opt for the Direct Plan.
However, keep in mind that it does not mean that a plan or fund/scheme with a low expense is always better.
If a mutual fund scheme with a higher expense ratio pursuing its unique investment mandate, style, and strategy, generates high returns, then it could compensate or justify the expense ratio charged.
Be a thoughtful investor.
Happy Investing!
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here…
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