What is the Total Expense Ratio?

Investing in mutual funds or alternative investment funds (AIF) involves understanding various charges and fees. One of the crucial components is the Total Expense Ratio (TER). TER represents the percentage of a fund’s assets used for administrative, management, and other operating expenses. 

Knowing TER helps investors compare different funds and understand their overall costs. This blog will explain what TER is, how it works, its impact on your investments, and how to calculate it. 

Total Expense Ratio Overview

The Total Expense Ratio (TER) is a key term to understand when investing in mutual funds or alternative investment funds (AIFs). TER represents the percentage of a fund’s assets that go towards paying the fund’s expenses. 

These expenses include management fees, administrative fees, and other operating costs needed to run the fund.

Think of TER as the cost of managing the fund. If a mutual fund has a TER of 1%, it means that 1% of the fund’s total assets are used to cover these expenses every year. This cost is deducted from the fund’s returns, so it directly impacts how much money you make from your investment.

For example, if you invest ₹10,000 in a fund with a TER of 1%, ₹100 of your investment will go towards paying these expenses annually. The lower the TER, the less you pay in fees, which can result in higher returns for you. On the other hand, a higher TER means higher costs, which can eat into your profits.

Understanding TER helps you compare different funds and make better investment decisions. By choosing funds with lower TERs, you can keep more of your money working for you.

How Does Total Expense Ratio Work?

The Total Expense Ratio (TER) shows how much it costs to manage and run an investment fund, such as a mutual fund or an alternative investment fund (AIF). It is expressed as a percentage of the fund’s total assets and includes costs like management fees, administrative fees, and other operating expenses.

Here’s how it works: imagine you invest in a mutual fund with a TER of 1.5%. This means that 1.5% of the fund’s total assets are used each year to cover the fund’s expenses. These costs are deducted from the fund’s assets, which reduces the amount of money available to generate returns for you.

For example, if you invest ₹10,000 in a fund with a 1.5% TER, ₹150 of your investment will go towards covering the fund’s expenses annually. The remaining ₹9,850 will be used to generate returns for you.

Formula of Total Expense Ratio

The Total Expense Ratio (TER) is calculated using a simple formula that helps investors understand the cost of managing a fund. Here’s the formula:

TER=Total Fund ExpensesTotal Fund Assets100

Let’s break this down:

The “Total Fund Expenses” include all the costs associated with running the fund, such as management fees, administrative fees, and other operational costs. 

The “Total Fund Assets” refer to the total value of all the investments held by the fund.

A lower TER means lower costs, which can lead to higher returns for you over time. On the other hand, a higher TER means higher costs, which can reduce your overall returns. 

It’s important to compare the TER of different funds before investing to ensure you are making the most cost-effective choice for your financial goals.

Calculation of Total Expense Ratio

Suppose you are investing in a mutual fund that has total annual expenses of ₹5,00,000 and total assets worth ₹50 crores. To find the TER, you would do the following calculation:

1. Convert the total assets into the same unit as the expenses. Here, ₹50 crores is ₹50,00,00,000.

2. Use the formula: TER = (5,00,000 / 50,00,00,000) X 100

3. Divide the total expenses by the total assets:

5,00,000 / 50,00,00,000= 0.001

4. Multiply by 100 to convert into percentage: 

0.001 X 100 = 0.1%

So, the TER for this mutual fund is 0.1%. This means that 0.1% of the fund’s total assets are used to cover its expenses each year. Understanding how to calculate TER helps you compare different funds and choose the most cost-effective options for your investments.

Impact of Total Expense Ratio

The Total Expense Ratio (TER) significantly impacts your investment returns. Here’s how:

Reduction in Returns

TER is deducted from the fund’s assets annually. If a fund has a TER of 2% and generates a return of 10%, your net return will be 8% after deducting the TER.

Long-term Effect

Over time, even small differences in TER can lead to large differences in investment growth. Lower TERs mean more of your money remains invested and grows over time.

Comparison is Key

When choosing between funds, comparing their TERs helps you understand which funds have lower costs. Lower costs can lead to higher net returns.

Erosion of Gains

High TERs can erode your investment gains. For instance, investing ₹1 lakh in two different funds with TERs of 1% and 2% will result in more growth in the fund with the lower TER over the long term.

Maximising Returns

Choosing funds with lower TERs helps you to increase your returns and achieve your financial objectives more effectively.

Example:

If a fund generates a 10% return but has a TER of 2%, your actual return is reduced to 8%. Over many years, this reduction can significantly impact your total investment value.

Limitation of Total Expense Ratio

Conclusion 

Understanding TER is crucial for making informed investment decisions. It helps you compare the costs of different funds and assess their impact on your returns. While TER is an important factor, it also considers other aspects like fund performance, risk, and investment goals. By choosing funds with lower TERs, you can maximise your returns over time. Stay informed and make smart investment choices!