The expense ratio in mutual funds plays an important role in deciding how much money you are making from your funds. The expense ratio refers to the amount charged by the fund houses for managing and operating the fund assets of the investors. It is charged on an annual basis. The expense ratio in mutual funds varies from one fund house to another. Some charge high, while others don’t. It is important to choose a fund house that does not charge a high expense ratio as it can impact your investments in several ways.
Here are some of the reasons why you should avoid mutual funds that come with high expense ratios:
One of the direct impacts of getting a high expense ratio in mutual funds is that it can cost a significant part of your returns. Let us understand this with the help of an example. Suppose you choose a fund house that charges a 2% expense ratio. The profit that you made in a given year is Rs 1000. This means that the profit that will be handed out to you after the deduction of the management fee and administrative cost of the fund house will be Rs 980 (1000 – 20% of 1000). On the other hand, if you have got a fund house that charges only a 1% expense ratio, the returns you will get on the same amount will be Rs 990. The figure might look marginal in a small profit. But imagine the returns to be around Rs 20 lakh. In that case, your returns will be reduced by Rs 20,000 if a 2% expense ratio is applied.
As it is evident, the higher the expense ratio in mutual funds, the lower will be the profit. Therefore, the most obvious reason to avoid mutual funds with a high expense ratio is that it will take a good chunk of your returns. For more information on the expense ratio, click the link given below:
Reduction in Your Invested Amount
If you like to invest then it is very likely that the profit that you make on your investment can be channelled in for further investment. Let’s say you redirect 50% of your profit to investment. But if the expense ratio is high, it means the profit you will be making will be lower. In that case, the amount of your investment will also be lower. So, in the long run, you are only going to miss out on the potential returns that you could make with the extra amount that went to the fund house.
Paying an unnecessarily high expense ratio in mutual fund does not make sense. There are many fund houses that provide asset management services and top-notch fund managers at an expense ratio of 0.5% to 1%. When you have such houses available, going for the ones that charge an expense ratio of around 2.5% to 3% will only add unnecessary expenditure to your bucket. Many investors like to revert to big fund houses for the simple reason that they seem more reliable. But when it comes to mutual funds, the thing that you need to look out for is the portfolio of the fund manager. If he seems worthy of managing your finance, it does not matter at what scale the fund house operates. Your ultimate goal is to reduce your expenses and increase your returns. And that can only happen when you get a fund house with a low expense ratio in mutual fund.
The expense ratio has a direct relation to profit. Therefore, it should be your priority to find a fund house that comes with a low expense ratio. In the longer run, it will work wonders for you and you won’t be losing out on your money bearing the unwanted expense.