What are the costs that mutual funds incur?
Mutual funds have a host of costs that they have to bear while raising money and which they pass it onto you. For example, in the initial part of raising funds they incur expenses pertaining to marketing costs like advertisements, commissions payable to brokers who sell the mutual fund scheme, legal charges to be paid for various approvals, etc. In addition that have to pay registrar and transfer agents who allot the mutual fund units and who manage the records and other details pertaining to investors.
Now, all of these expenses come in a category called the "total expense ratio" (TER).
How is TER calculated?
The total expense ratio is calculated as follows:
TER = (Total expenses during an accounting period) * 100 / Total net assets of the fund
Now let's cite this with an example. Let's say that a Mutual Fund has net assets to the tune of Rs 100 crores and the expenses of the fund are Rs 2 crores. Then the TER will work as follows:
2x100/100= Rs 2 crores
That's pretty reasonable for a mutual fund scheme.
Who bears the Rs 2crores?
Unfortunately, the Rs 2 crores has to be borne by the investors and the same is deducted and will have an impact on the net asset value of the mutual fund scheme. In fact, the net asset value of a mutual fund is always minus the TER.
It's important to remember that lower the TER higher would be the net asset value and hence your returns. Higher the TER would mean lower returns for you.
The Securities and Exchange Board of India recently allowed fungibility of TER. Earlier while charging TER the slab was 2.5 per cent, now slabs have been removed and it will be up to the fund house to decide the charges.
Apart from TER, investors have to bear costs like entry and exit loads in a mutual fund scheme that we would explain in another article.
If you get an opportunity do not forget to study the TER in a mutual find. Always remember that as an investor, you are the one who will be impacted as your returns would be lower if TER of the Mutual Fund Scheme is high.