Mutual Fund Investment: Why expense ratio of your mutual fund is important

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New Delhi | Updated: September 3, 2018 12:45:05 PM

Invest in a mutual fund scheme that has lower expense ratio, prudent investment philosophy and steady performance.

Your Money: Why expense ratio of your mutual fund is important (Illustration: Shyam Kumar Prasad)

Mutual funds (MFs) are one of the smartest ways of investments available today. Liquid funds are your parking lots for that contingency fund (this could be your income of 4-6 months), multi asset funds are those multi-talented funds that work as a great diversification tool when you want the best of all three asset classes—equity, debt and gold. Then comes the turn to introduce you to one of the very popular investment avenues in mutual funds—diversified equity mutual funds.

These are like your best friend—with you for the long-term. As a disciplined investor you should link your investments to equity mutual funds with your long-term financial goals. However, there are over 400 equity mutual funds in India today. Which one do you choose? The one from the most “famous” fund house? Or the one which your friend has invested in? Or the one that has top ratings?
Goal-based investing

Doing some homework before investing your money is necessary. Things you must look at before investing are identifying your investment goals and objectives of that fund and checking if it matches your risk tolerance. The lower the better, and last but not the least, is the expense ratio of the fund. The expense ratio of a fund is by far one of the most ignored and ‘tiny’ looking number. Those 2.5%, 2.3%, 1.8% types that are mentioned with other important fund details do affect your investment a lot. Investors often tend to underestimate the impact of this ratio on their mutual fund portfolio.

Expense ratio

Expense ratio is a measure of what it costs an investment company to operate a mutual fund. This is expressed as a ratio of your overall investments with the fund. The largest component of the expense ratio is the fees paid for managing your money. For example, if you invest Rs 10,000 in a fund with an expense ratio of 1.5%, then you are paying the fund Rs 150 per year to manage your money.
Every fund house charges different expense ratios for different schemes. Regardless of the scheme performance, the fund house charges you that expense ratio. Therefore, it makes complete sense to go for funds with lower expense ratios.

Although low expense ratio is not just the only thing one must look for in a good fund. The fund philosophy also matters—a fund house focused on costs may lower expense ratio on a matter of principle, a fund house wanting more AUM may drop expense ratios for a completely different reason.

Therefore, the formula for a good fund should be combination of steady performance over the long term by following prudent investment philosophy with minimal expenses. To avoid high impact of high expense ratio, it is important to do your homework and choose a fund that has a combination of low expense and prudent investment philosophy.

(Source: Quantum Mutual Fund)

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