The increasing popularity and awareness about mutual funds has led to a sudden surge in the number of people investing in funds today. However, most people do not know that there is a charge in mutual fund investment as well that is deducted as the pay for managing your investment money.
Just like any other business service, a mutual fund is also a service and the fee that is charged is in the form of expense ratio. Now that you know the definition of expense ratio, let us discuss all about the expense ratio in mutual funds and how it works below.
When we discuss expense ratio in mutual fund, all the investors are liable to pay a percent of their earnings to cover the total expenses incurred by the mutual fund providers to manage your investment. Under expense ratio in mutual fund, a range of different costs are included like the distribution cost, the management cost, the administrative cost, the record-keeping fees, the marketing costs, the compliance cost, etc.
The expense ratio is calculated yearly and has a direct impact on the returns earned by the investors as the expense ratio amount is deducted before the total value of investment is credited to the investor. It is evident that given the role of expense ratio in mutual fund, the higher the ratio the more it will eat up your returns. You can read more on expense ratio here.
The calculation of the expense ratio in mutual fund is directly dependent on the assets you own and the expense ratio percent. To get the expense ratio, you need to divide your total expenses by the calculated average value of the investment portfolio.
The expense ratio percent is calculated on the basis of regulations passed for different types of funds. For expense ratio in mutual fund, it is said that 1% is an average charge, but on the higher side. The actual formula is as follows:
Total Expenses/Total Assets= Expense Ratio
Now that you know the relevance of expense ratio in mutual fund, you should also know how the expense ratio impacts your total returns and why it is relevant or important to you. Just remember these key things when you begin your investment in any mutual fund.
- Given the impact of expense ratio in mutual fund, the higher the expense ratio, the lower will be your long-term returns. Similarly, if you invest in a mutual fund with a lower expense ratio, you indirectly increase your potential returns on your investment.
- One good thing about expense ratio is that it helps you decide between the different types of funds available to see which one you want to invest in.
- The expense ratio also helps determine the potential achievable profit on all their investments, as a whole of their portfolio value.
- Lastly, there is a gross expense ratio that you should be aware of. The gross expense ratio in mutual fund consists of the expenses like advertising cost, administration cost, etc. On the other hand, the net expense ratio in mutual fund consists of costs like reimbursement costs, waivers, etc.
Overall, the decision of investing in a mutual fund is very beneficial for everyone in the long run. However, not being aware of the potential costs and going forward without ample research can result in bad management of the investment. The expense ratio is an important part of mutual fund investment, so study it well before investing in any mutual fund.