Mutual funds are professionally managed assets. It pools money from a large number of investors and invests it in different mutual fund schemes. While choosing a fund house, one of the important aspects evaluated by investors is the Annual Fund Operating Expense, generally known as expenses ratio. Anexpense ratio is the amount charged by the companies or brokerage firms to manage a mutual fund. The expense ratio is the percentage you pay to a firm for managing and operating your assets.
If you invest Rs. 50,000 in a fund that has an expense ratio of 2% then the amount you need to pay to the fund house for management of your fund is Rs. 1,000. So, if your fund gets a return of 13% and your expense ratio is 2%, then your returns are equal to 11%. Thus it is a small percentage of the money you are paying to the fund house to take care of your investment.
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The mutual fund schemes can be costly to manage and operate. A fund manager professionally manages your money, actively monitors your investments, searches new investments and helps you to get returns according to your investments goals. This is a labour-intensive task and most of the top fund houses engage highly skilled professionals to operate the mutual funds.
There are two types of asset management. Some assets are managed actively and some assets like the index funds are managed passively. In case of actively managed mutual fund schemes, the expense ratio charged is more than the passively managed schemes. The expense ratio gives the investor the idea of how efficiently the funds are being managed. The expenses ratio can be an important indicator in selecting mutual fund schemes as it impacts the overall returns you can earn.
For calculating the expense ratio, fund houses use the formula of dividing the fund operating expenses with the average value of fund assets.
Expense ratio = operating expenses/average value of assets
As you can notice, only the operating expenditures are used in the expanse ratio formula. Other factors like the sales commission and loads are excluded. This is because these costs are not related to running the funds on a regular basis. These are one-time costs paid by the investor during the purchase or sale of his assets in the fund.
The expense ratio can be used to understand the difference between the management and operational skills of various fund houses. A higher ratio indicates more expenses are made to manage the assets whereas a lower ratio indicates that lesser cost in incurred to manage the same amount of assets. In conclusion, the expense ratio will help you to understand how efficiently your assets are managed.
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To provide relief to the Indian investors and control the pricing of the fund houses, the market regulator SEBI brought about a revamp in the fee structure charged by the fund houses to investors. SEBI issued new norms and capped the expenses for investments of such funds at a maximum of 2.25%.
The capping of the fee structure by the Securities and Exchange Board of India (SEBI) has helped rationalize the Total Expenses Ratio (TER) and the fee charged by the brokerage firms from investors every year for the management of their assets.
The new fee structure was scheduled to become effective from 1st April 2019. The market regulators have capped the TER at 1.25% for close-ended equity schemes and 1% for assets other than equity mutual fund schemes. The cap for open-ended equity schemes is a maximum of 2.25% whereas for other open-ended mutual fund schemes the limit is set at 2%.
SEBI has set a ceiling based on which the fund houses can charge its investors.It states, the expenses ratio will come down as the AUM (asset under management) increases. It has specified various slab based on the AUM for open-ended mutual fund schemes. For the first 500 crores, the fund houses can charge the maximum ratio i.e. 2.25%. The cost will come down to 2% for the next slab ranging from 750 crores to 2,000 crores daily net assets. For the subsequent 2,000 to 5,000 crores, it will be 1.75% and 1.6 % for Rs 5,000 crores to 10,000 crores, 1.5 per cent for Rs 10,000 crore-50,000 crores with a reduction of 0.05 per cent for every increase of 5000 crores. For equity MFs with the daily net assets of Rs.40,000cr, the TER will decline by 0.05% for every increase of Rs. 5,000crores in daily net assets.
Like all mutual fund schemes, the exchange-traded funds and index funds come with an expense ratio that must be borne by the investors for the management of their assets.
The exchange-traded funds is an investment scheme that pools money from investors and invests in diversified securities including bonds, equities, commodities, etc. The EFT comes with various types of charges like any other mutual fund scheme,such as payment of a certain percentage of the transaction value as brokerage charge. ETF is considered to be a cost-efficient product due to the low expense ratio. A lower fund management fee can help the investor save money and therefore, increase payouts in the long term.
The index funds are also mutual fund schemes that come with an expense ratio. But the main benefit of index funds is that the expense ratio is the only cost you need to bear. The index funds are managed passively so the expense ratio becomes less compared to the actively managed ones. The actively managed funds charge anything between 1-2% of total expenses ratio compared to which the index fund charges anything from 0.20% to 0.50%.
An expense ratio calculator is an online tool that allows you to compute the investment returns. The expanse ratio calculator will allow you to understand how much of the added expenses ratio will hurt your investments. You can either calculate your returns on investments by using the online expenses ratio calculator or by using the formula mentioned above.
The online expense ratio calculator eases the process of calculation for the investor. It allows you to understand how the expense ratio can impact your returns in the long run. You can also compare two similar mutual fund schemes and determine which investment is more profitable for you.
High expense ratio will impact the returns of your investments but it cannot be considered a negative aspect altogether. If your fund house manages the assets efficiently, then it is likely that you will get high returns on your investments. Such fund houses charge high expenses ratio based on various factors like choice of investment and allotmentof highly skilled fund managers.
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