All you Need to Know about Expense Ratio

Expense ratio is the charges levied by the operators of a Mutual Fund, Exchange Traded Funds (ETF), or any investment portfolio for their financial expenses. Typically, it is an annual maintenance charge (AMC) for the investor of a fund. The yearly charge includes the operating costs, management fees, advertising costs, and other miscellaneous expenses the fund operators make. There are different components of the total expense ratio that determine the charges for operating a fund plan. All fund managers levy these charges on the investors, but they can vary according to various factors.

In this article, let us dive further into the topic and understand more about this ratio.

What is the importance of the Expense Ratio?

Simply put, the total expense ratio is the fee you pay to the manager of a fund for taking care of the operations and marketing of your funds. The operating expenses can reduce the asset value of a fund, therefore decreasing the returns on your investment. Hence, it is important to know this ratio.

Formula of Expense Ratio:

A higher expense ratio means that the total cost for the fund will be more. A lower expense ratio indicates that the total cost for the fund will be less. The fund's total asset value also plays an essential role in the determination of the expense ratio.

*Note An elevated total expense ratio results in a higher percentage of the annual charge for the investor.

The total expense ratio also varies with the type of fund. Actively managed funds typically have a higher expense ratio, while passively managed funds have a lower ratio.

What are the Different Components of the Total Expense Ratio?

The expense ratio of a fund is not affected by the variation in the cost of the underlying asset in the fund. Some components do affect the total expense ratio. The three most significant components are:

  • Management Fees – The management of a fund requires a comprehensive team of analysts and researchers. This fee is compensation for these analysts and researchers. The annual management fee is 0.5-1% of the total asset value of the fund.

  • Administrative Fees – This fee is associated with the smooth running of a fund. Different parts of the administrative fee include record maintenance, customer support, and the entry and exit fees of the portfolio asset. This fee varies vastly with different funds.

  • 12-1b Fee – This fee considers the advertising and promotion of the funds. It is generally 0.25 – 0.75% of the total asset value of the fund.

ETF Expense Ratio vs Mutual Fund Expense Ratio:

Exchange-Traded Funds are an investment vehicle that tracks an underlying index. The underlying securities in an ETF are in the same proportion of a particular market index. Their management is passive, as analysts and experts do not decide the buying and selling of the securities in the fund. This makes the total ETF expense ratio lower than that of actively managed funds.

In Mutual Funds, a comprehensive team of analysts and experts decide what securities are bought and sold. This increases the management fees of that Mutual Fund significantly, increasing the total Expense Ratio.

The expense ratio can affect the annual charge you pay for a fund. A higher expense ratio can reduce your potential returns from an investment. Therefore, knowing the expense ratio before investing is essential.

So before you open a Demat Account is crucial to invest in funds, ensure that you are well are of the expense ratio.

To open an Individual Demat Account with HDFC Bank, click here.

Read more on the difference between ETFs and Mutual Funds by clicking here.

*Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.