Investment word of the day: Total expense ratio — what is TER in mutual funds and how is it calculated?

Investment word of the day: If you plan to invest in mutual funds, it becomes important to understand that there are certain costs associated with them. Mutual funds levy certain operating expenses to cover the costs of managing a scheme. Hence, as a mutual fund investor, it becomes essential to know such costs to make smarter investment decisions.

What is total expense ratio?

According to the Sebi (Mutual Funds) Regulations, 1996, Mutual Funds are allowed to charge certain operating expenses for managing a mutual fund scheme.

These expenses may include sales, marketing or advertising expenses, administrative expenses, transaction costs, investment management fees, registrar fees, custodian fees, and audit fees, which are a percentage of the fund’s daily net assets. Such expenses are incurred to manage a mutual fund scheme and are collectively called as total expense ratio.

How is the total expense ratio calculated?

It is calculated as a percentage of the scheme average Net Asset Value (NAV), which is per unit market value of a mutual fund or other investment company. In India, the expense ratio is fungible, which means there is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit.

The formula to calculate the total expense ratio is —

TER = (Total Costs Incurred / Total Net Assets) * 100, where total expenses indicate all costs incurred to handle the fund, which includes administration costs, audit costs, transaction costs, Legal and accountancy fees, sales and marketing expenses or any other operational expenses.

Total fund assets show the market value of all the stocks and bonds the fund is invested in on a particular date.

What is a good expense ratio?

It must be noted that a high expense ratio does not always mean poor returns. At times, a mutual fund with lower returns may have a low expense ratio, whereas a fund with higher returns may have a higher expense ratio.

However, it becomes essential for investors to compare the total expense ratio with the returns. Although expense ratio is an important metric to consider before investing in a mutual fund, there are other factors such as risk tolerance, investment objectives, other features of the fund, etc.