When investing in mutual funds, one of the most important factors to consider is the total expense ratio (TER). Investors need to understand this concept as it directly impacts the returns on investments.
What is the Total Expense Ratio?
TER refers to the cost of investing in mutual funds including index funds. It includes expenses such as management fees, administrative fees, and other operating expenses. TER is expressed as a percentage of a fund's assets under management.
Impact of returns
The expenses can eat into one’s returns. For instance, let’s imagine you invest ₹10,000 in a fund with a 1% TER. This fund delivers an annual return of 7% on average over the ten years. In that case, your investment (adjusted for TER) will be worth approximately ₹19,671. However, if you had invested in a fund with a 0.5% TER, your total investment would be worth approximately $20,770 in the same period. This means the lower the TER, the higher the returns.
Passive investment avenues like the index fund tend to have lower TER as compared to actively managed funds. This is because the management and transaction fees of a passively managed fund are relatively low.
Cost efficient
A low TER may indicate that the fund is managed efficiently and effectively.
In contrast, when you invest in a fund with a high TER, it can be more difficult to determine whether the fees associated with the fund are fair and reasonable. High fees can also be a red flag for poor management or excessive expenses, which can ultimately impact your investment returns.
Opportunity to outperform
A low total expense ratio means that a mutual fund is more likely to outperform other funds with higher expense ratios. This can give the fund a competitive advantage and help it to generate better returns for its investors.
How to Choose a Low TER Fund?
Here are the steps you can take when selecting a fund with a low total expense ratio:
- Conducting thorough research on the fund's investment strategy and asset allocation
- Reviewing the fund's past performance and considering its risk profile
- Comparing the fund's total expense ratio to similar funds in the same category
- Consulting with a financial advisor or investment professional for additional guidance and advice