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Saturday, 13 January 2018

Expense ratio of a mutual fund

Expense ratio tells that how much a fund is expending to run the business. Rest would be invested. We cant judge a fund on the basis of expense ratio. It is used for all type of expenses like salaries, agent commission, office expenses etc. A good fund manager can charge more salary than the other fund manager. A newer fund house may offer higher commission to its agent. All these are included in expense ratio. Since this is charged regularly (every year), a high expense ratio over the long-term may reduce your returns through power of compounding. 
As per SEBI regulations, the maximum expense ratio of an equity fund can be 2.5% and for a debt fund, it should not cross 2.25%. There is an additional allowance 0.3 per cent given for selling in Tier II and Tier III cities for equity schemes. The return from an fund returns is always exposed after such expense ratio.
The expense is charged on daily basis. Suppose some fine day NAV of a fund is 100rs and it is moved 5%then the final NAV would not be 105. If the expense ratio is 2% then the expense ratio for that particular day would be 2%/365 (that’s 365th part of 2% as charges, as it’s for 1 day, remember 365 days in a year) and the final NAV would be 105-0.5479=104.45rs.
There is no correlation between expense ratio and performance. So don't decide the fund to invest on expense ratio. There are other elements to consider before coming to expense ratio. Go for the fund which has good consistent CAGR return for 3 to 5 years against its benchmark. If there are two equally good performers and one has a lower expense ratio than the other, then you should perhaps go for the first one.

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