When you invest in mutual funds, you often hear the phrase expense ratio. Many new investors assume it is just a minor charge that does not impact their overall returns. However, this small percentage plays a bigger role in determining the wealth you eventually accumulate than most people realise.
Every mutual fund house incurs costs to run a scheme. These include fund management fees, transaction costs, administrative expenses, custodian charges, audit fees, registrar charges, sales and marketing expenses. Instead of billing investors separately for each of these, all costs are bundled together and expressed as a percentage of the assets under management. This percentage is known as the Total Expense Ratio or TER.
The expense ratio is deducted from the scheme’s net asset value on a daily basis. You never see it as a separate charge, but its impact is real. The lower the expense ratio, the higher the NAV, and that directly affects the value of your investment over time.
To put this into perspective, suppose you invest in a mutual fund through a direct plan. Direct plans cut out distributors and intermediaries, which means no commissions and therefore a lower expense ratio. Regular plans on the other hand include distributor commissions, making them more expensive. Even a difference of half a percent in expense ratio between a direct and regular plan may appear insignificant in the short term. But over a period of 20 or 30 years, that small difference compounds and can reduce your wealth by several lakhs or even crores.
For example, if you invest ten lakh rupees in a fund growing at twelve percent annually, the value of your investment in a direct plan after thirty years could be nearly three crore rupees. The same investment in a regular plan with just half a percent higher expense ratio may grow to only around two crore sixty lakh rupees. With a one percent higher ratio, it could reduce to about two crore thirty lakh rupees. That is a big difference, simply because of the compounding effect of costs.
This is why experts often say that costs matter just as much as returns when it comes to investing. Choosing a mutual fund with a lower expense ratio can help you retain more of your returns, especially when you are investing for the long term. At the same time, it is important to remember that a lower expense ratio does not automatically make a fund the best choice.
You need to look at other factors such as the fund’s past performance, consistency across market cycles, the quality of its portfolio, the expertise of the fund management team, and how effectively the scheme is managed. A fund with a slightly higher expense ratio but stronger performance may still be better than one with the lowest ratio but weak returns.
The key takeaway for investors is to be aware of the expense ratio, understand how it affects compounding, and balance it with other selection criteria when choosing a mutual fund. If you want to keep costs low, direct plans are worth considering, especially for long term wealth creation.
Expense ratio may sound technical, but in reality it is one of the simplest and most important aspects of investing in mutual funds. By paying attention to it, you are not just saving on costs, you are giving yourself a better chance to build a larger financial corpus for your goals.
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