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# Total Expense Ratio: What is TER in Mutual Funds

5 Mins 14 Feb 2023 0 COMMENT

What is the Impact of TER in mutual funds on returns?

Investing in mutual funds comes at a cost. There are certain expenses that an investor has to pay while investing in mutual funds. When making any investment decision, it is important to know all the associated costs with investing and one such cost is the total expenses ratio.

## What is total expenses ratio (TER)?

Total Expense ratio can be termed as the amount of money that a mutual fund house charges to its clients to finance its operations, administrative costs and for maintenance charges. The ratio is a representation of the expense in relation to the assets of the mutual fund.

This is a cost that an investor bear which also reduces the investment value by a small amount. Therefore, it is always beneficial for an investor to select a fund with a lower expense ratio.

## What is Total Expense Ratio (TER) formula?

There isn't actually a formula you use yourself for TER. It's a percentage calculated by dividing a fund's annual operating costs by its total assets.

TER = (Yearly Fund Expenses) / (Total Amount Invested) *100.

The lower the percentage, the less fees eat into your returns.

## How does Total Expense Ratio (TER) work?

1. Understanding Total Expense Ratio: It refers to the total costs incurred to manage and operate an investment fund, and its proportionate charge to investors against its contribution to the fund.
2. Calculation: TER is expressed in percentage terms; it is the total annual cost expressed in relation to the average net assets of the fund. These include management fees, administrative expenses, operating costs, and any other kind of fees.
3. Return Impact: The greater the TER, the more percentage of assets consumed by expenses, which will slightly reduce the net return for investors.
4. Comparison Tool: TER can be a comparative tool to help investors gauge the cost efficiency of particular funds. A lower TER would indicate that a fund is more cost-effective.
5. Inclusion in mutual funds: As the TER drastically reduces the net asset value per unit of any mutual fund, it therefore affects the buying or selling price of the units by the investors.
6. Transparency: Quite often, the regulatory bodies ask the funds to disclose their TER so that investors can be made aware of the charges that would be levied.
7. Consideration for investment: When selecting a fund, one should consider the TER as one of the criteria, besides checking the performance history of the fund, its investing objectives, and risk profile.

## Major costs that add up to TER in mutual funds

To be an informed investor, it is helpful to understand the various components of the expense ratio.

### Management fees

For a mutual fund scheme to generate higher returns, it is important to manage it properly and ensure that investment objectives are met. The management fees are charged in order to pay the fund and portfolio managers who make important decisions related to the fund. Usually, around 0.5-1% of the total asset base is allocated as management fees.

### Legal fees

Many investors trust mutual funds as a good investment vehicle. In order to uphold this image, a fund needs to comply with the laws, rules and regulations. The fund also needs to be audited in order to make sure that all the schemes and processes of the fund are in check. A part of the expenses ratio is used to meet the costs that arise out of the various legal and auditing procedures.

### Costs associated with marketing

As a fund, it is important to raise awareness and get investors to invest money in the fund. Most funds operate on a large scale therefore, the costs associated with marketing and distribution is an important component in the expense ratio. The costs of acquiring a new investor are calculated under 12-b FEE. In order to distribute a regular mutual fund, a broker is required. These costs are calculated in the expense ratio as well.

Apart from these costs, the expense ratio also comprises the maintenance, administrative, brokerage fees, entry and exit loads.

## Importance of Total Expense Ratio in Mutual Funds

Expense ratio is a critical factor when analyzing or making investing decisions. Here are some reasons that highlight the importance of the expense ratio

### Comparing different funds

Expense ratio is helpful in order to compare different funds. Since the expense ratio affects the returns and has a direct impact, an investor can use the ratio as one of the factors to compare various funds. The higher the expense ratio, the lower the returns. Using the expense ratio to compare funds can be helpful especially if the funds are similar in nature.

### Effect on debt funds

The expense ratio is significant when it comes to debt funds. Since debt funds offer low returns, the expense ratio might eat away at some of the profits generated by the fund. Therefore, an investor should carefully look at the expense ratio of a debt fund before investing in one.

### Fund performance

Typically, we associate high costs with high quality but that might not always be the case. Similarly, while looking at funds, it is important to consider other factors as well. A fund might not perform well in spite of having a high expense ratio. Certain funds can be well managed and provide significant returns even with a lower expense ratio.

## How Does the Expense Ratio Impact Fund Return?

The expense ratio is inversely related to the size of the mutual fund. This means that larger mutual funds usually have a lower expense ratio. The expense ratio is important as it is deducted from the revenue of the funds. Higher expense ratios will often chip away at the returns, affecting the mutual fund and the investors.

As an investor, the expense ratio should be a factor that you consider along with various other aspects of a mutual fund. Knowing the various costs associated with mutual funds and how they will affect your returns is important. While selecting a mutual fund, an investor should also look at the management, risk level and asset allocation.

## SEBI limit on TER in mutual funds

 Category Assets Under Management (AUM) Maximum TER for Equity Funds Maximum TER for Debt Funds First slab Up to Rs. 500 Cr 2.25% 2.00% Second slab Next Rs. 250 Cr 2.00% 1.75% Third slab Next Rs. 1,250 Cr 1.75% 1.50% Fourth slab Next Rs. 3,000 Cr 1.60% 1.35% Fifth slab Next Rs. 5,000 Cr 1.50% 1.25% Sixth slab Next Rs. 40,000 Cr Decrease of 0.05% per Rs. 5,000 crore increase Decrease of 0.05% per Rs. 5,000 crore increase Seventh slab Above Rs. 50,000 Cr 1.05% 0.80%

## What is the Impact of TER in mutual funds on returns?

Imagine TER as a money vacuum in your mutual fund. A higher TER sucks out more from your investment each year. This lowers your overall returns. Even a small difference in TER can add up significantly over time, especially in long-term investments. So, choosing funds with lower TERs helps you keep more of your hard-earned profits.

## Difference Between Total Expense Ratio (TER) and Gross Expense Ratio (GER)

 Basis TER GER Definition The percentage of a mutual fund's assets used for operational and administrative expenses. Includes all expenses in TER plus additional costs like sales charges and transaction fees. Scope Covers management fees, administrative costs, and other operational expenses. Broader, covering everything in TER and extra costs related to buying and selling securities. Impact on Returns Directly affects net returns by reducing the total returns earned by investors Gives a more comprehensive view of total costs, impacting overall investment performance Investor Awareness Commonly highlighted to investors for understanding routine expenses. Important for recognizing all potential costs, including less obvious ones.

## What Are the Limitations of the Total Expense Ratio (TER)?

TER is a great tool, but it's not perfect:

1. Performance Matters: A low-TER fund might underperform a high-TER fund. Look beyond cost; consider the fund's track record too.
3. Actively vs. Passively: Lower TERs are more expected in passively managed funds (like index funds). Don't compare apples to oranges!

## FAQs of Total Expense Ratio(TER)

### How to calculate total expense ratio?

Total expense ratio is calculated by dividing the total costs of the mutual fund by the total assets of the mutual fund.

### What is a good total expense ratio?

A total expense ratio between 0.5% and 0.75% is considered to be good in the case of an actively managed fund.

### How does expense ratio get paid?

A percentage of the total expense ratio is deducted daily from the invested value. For example, if the expense ratio is 1% then 1/365 = 0.0027% of the invested value is deducted daily

### What is an expense ratio in mutual fund?

The expense ratio is like a yearly maintenance fee for your mutual fund. It covers costs like management and trading. A lower expense ratio means more of your money goes towards potential returns and less towards fees.

### What is an example of a total expense ratio?

Expense ratios typically range from around 0.10% to 2.00% annually. For example, a 1.00% expense ratio means for every ₹10,000 invested, ₹100 goes towards fund costs each year.

### What is total expense ratio NAV?

There actually isn't a separate term "total expense ratio NAV." TER is a percentage that reflects fund costs, not a specific value on the NAV. The NAV itself already accounts for TER by deducting expenses before calculating the price per unit.