Expense ratio: A small difference can make a big dent in your overall returns

What is the most relevant to you when you invest in mutual funds? A lot of you would say the returns. People want the highest possible returns on their money. What they miss out on, however, is the cost. Nothing in the world comes for free.

Even wondered how much do you pay to the asset management companies when you invest in an MF scheme? AMCs club the fund management, transaction cost and other such expenses under Total Expense Ratio (TER) which is the overall cost that you pay to AMCs. This cost could be anywhere up to 2.5 percent, depending on the scheme you have invested.

“Expense ratios are guided by SEBI’s regulations. These are dynamic in nature because factors such as the size of the fund, percentage of inflows from beyond the top 30 cities, and taxes determine its level for different MF schemes,” says Adhil Shetty, CEO, Bank bazaar.com.

Why expense ratio matters?

You may feel even if the TER is 2.5 per cent, it is too less. However, even 1 percent. TER affects your returns hugely if you hold your investments for the long-term. The underlying stocks could be the same, but the difference in expense ratio is enough to make a dent in your returns if TER is on the higher side in your case.

We have compiled a table on regular and direct plans of the same mutual fund scheme to explain the concept. For uninitiated, direct mutual funds are those that you directly buy from the AMC. Regular MFs are those that you buy from a mutual fund distributor. The expense ratio of regular plans is always higher than that in direct plans even as the portfolio composition is exactly the same.

Regular vs Direct Investment- How TER eats away your return on investment?

Data collated on 12th Aug 2022.

Average annualised return for past 5 years, as on 11 Aug 2022.

Total Expense Ratio (TER) as on 11 Aug 2022

Source: BankBazaar.com

Data compiled by BankBazaar.com shows the expense ratio of ‘Axis Bluechip Fund – Regular’ is 1.6 per cent. Axis Bluechip Fund- Direct has an expense ratio of 0.5 per cent. We have calculated the annualised returns of both the funds for the last 5 years factoring in the expense ratio. For regular it is 14 per cent while for direct it is 15.46 per cent. If you do an SIP of ₹10,000 for the next 5 years, you would accumulate ₹8.72 lakh in case of Axis Bluechip Fund – Regular.

However, if you go for Axis Bluechip Fund- Direct, you would make ₹36,267 extra at ₹9.19 lakh. The difference will keep growing as the years go by. In 15 years, it would be as high as ₹9.53 lakh.

“Expense ratio is one of the important points of consideration when picking a fund but needs to be seen in balance with the other points. For example, a fund with a low cost but also with poor performance compared to its peers may not be as good an option as a fund with a higher cost but with better performance. With respect to the plan, you may want to invest via a direct plan instead of a regular one over the long term because the difference to your returns could become significant,” says Shetty.

It is in this context that the debate over index funds versus active funds has become relevant. The direct plan of a Nifty index fund may charge you less than 0.5 per cent. However, a bluechip fund comprising mostly the same stocks as the Nifty50 index may charge much higher.

For example, ICICI Prudential Nifty index fund charges 0.18 per cent in its direct plan. The direct plan of ICICI Prudential Bluechip Fund has an expense ratio of 1.07 per cent. Even if ICICI Bluechip outperforms the Nifty50 index fund, the post-expense ratio returns could be similar.

One doesn’t have to go for the funds with the lowest expense ratio. But, always be aware of the cost of your investment.

Aprajita Sharma is a freelance journalist and a certified financial planner. She can be reached at @apri_sharma on Twitter and LinkedIn.