What Are The Importance of Total Expense Ration in Mutual Funds?

What Are The Importance of Total Expense Ration in Mutual Funds?

March 06, 2024

Mutual funds are a popular investment instrument that pools money from multiple investors and invests them in various financial assets. The success of mutual funds depends on their ability to generate adequate returns for investors while minimizing costs. A key determinant of the cost of investing in mutual funds is the Total Expense Ratio (TER).
 

TER is the percentage of a fund’s net asset value that goes towards covering the expenses of managing the fund. It encompasses a broad range of costs, including administrative fees, fund management fees, marketing expenses, and other costs. It is expressed as a percentage and is deducted directly from the investor's returns, hence TER can have a significant impact on the ultimate returns of investors.
 

High TERs can significantly erode the returns of mutual funds, making it important for investors to keep an eye on them while selecting their investment portfolios. For instance, suppose an investment of Rs 10,000 in a particular mutual fund that delivers a return of 10%, but has a TER of 3%. In that case, the investor would end up getting a return of only 7%, subsequently decreasing the return on investment.
 

Different types of mutual funds have varying TERs. While index funds have the lowest TERs, actively managed funds generally have higher TERs due to the higher costs involved in research and analysis. Similarly, Equity mutual funds have higher TERs compared to debt funds due to the higher fluctuations in their returns as opposed to debt funds. Therefore, it becomes important for investors to understand the costs involved with different types of mutual funds before making their investment decisions.
 

The importance of TER goes beyond just the cost of investing. Lower TERs also indicate that fund managers are managing the investments efficiently by keeping costs low, thereby increasing the capital available for investments. TER thus becomes one of the key indicators of the quality of a mutual fund.
 

As an example, if one assumes two mutual funds A and B with net asset values of Rs 100 and Rs 200; both providing 10% returns, but A having a TER of 1% and B has a TER of 2%. In that case, for every investment of Rs 100, A would provide a return of Rs 9, and B would provide a return of Rs 8. Lower TER in this case leads to higher returns for the investor.

In conclusion, TER is an important consideration for making smart investment decisions in mutual funds. It helps investors understand the true cost of their investments while potentially generating higher returns. However, it is important to evaluate the complete investment portfolio, including the underlying mutual fund, alongside TER before investing, especially for investors in the Indian financial market. It is advisable to keep in mind the fluctuations in the market and perform thorough research before making investment decisions.


 

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