Investing comes with a cost. In general, exchange-traded funds (ETF) and mutual funds charge a variety of varying costs, and many of that gets wrapped into a figure known as the total expense ratio. This article will serve as a guide to everything you need to know about toal expense ratio irrespective of the types of investment you invest in.
What is the total expense ratio?
Expense ratio is the total cost of operating and managing an investment fund, such as a mutual fund scheme. These costs usually consist of management fees and additional expenses such as legal fees, trading fees, auditor fees, and any other operational expenses. To derive the total expense ratio (TER), simply divide the fund’s total assets with the total cost of the fund. TER is also known as after reimbursement expense ratio or net expense ratio
The formula for calculating TER
Following is the formula and the steps required to calculate the TER
TER = Total fund costs / Total fund assets
To calculate the TER:
- Determine the total assets of the fund, that can be easily derived from financial disclosures that a fund reports to regulators or are dispersed to investors and analysts via a prospectus.
- Next, determine the total costs of the fund from the prospectus, that can be even more challenging, as TER accounts for all expenses associated with managing and operating the fund such as management costs, trading costs, administration and overhead costs (such as the costs associated with marketing the fund).
Why is total expense ratio important?
While mutual fund houses in the developed nations charge a variety of costs and fees to the investors, in India, almost all the expenses are clubbed together into a single metric of the TER (the only cost not included in the TER is the exit load). The two main components in the expense ratio are the distributors’ commission and the fund manager’s fees. Though an investor does not directly pay a commission to the distributors when investing in mutual funds, the fund house pays it and charges it against the investor as a part of the total expense ratio.
Why should you as an investor care about the TER?
The returns on your mutual fund investments depend on the growth of the NAV (net asset value) of the fund. The NAV of a fund is calculated after reducing the TER from the fund’s portfolio. Hence, the higher the total expense ratio, lower is the NAV of the fund, and eventually the lower the money you take home as an investor.
How can you find about the TER of your mutual fund scheme?
AMCs (asset management company) must disclose the total expense ratio of all their schemes on their websites and on the website of AMFI (Association of Mutual Funds in India) on a daily basis.
Irrespective of the type of mutual funds you decide to invest in, make sure to check their TER before you choose to invest in mutual funds. Happy investing!