How does the expense ratio affect your mutual fund return?

A mutual fund is a popular investment option for those who want to diversify their portfolio and invest in a variety of assets. The expense ratio is an important factor to consider when you invest your money in mutual funds. 

What is an expense ratio?

The expense ratio is the proportion of the fund’s assets used to cover its operating costs. It reflects the total expenses the fund incurs to oversee its investments and overall functions. It is the total cost incurred by the fund to manage its investments and operations. 

This indicator is expressed as a percentage of the net assets of the fund. For example, if a mutual fund has an expense ratio of 1%, it means that 1% of the fund’s assets are used to pay for expenses.

You should consider this indicator when selecting a mutual fund. Because it affects the long-term returns on your investment. 

Lower expense ratios are good since they allow a higher portion of the fund’s return to be allocated to you. But there are other crucial factors to consider when deciding to invest such as the fund’s investment strategy, previous performance, and risk level.

How does the expense ratio affect investment return?

Expense ratio and investment return

The expense ratio of a mutual fund is a crucial factor that affects your returns. In other words, it is directly related to how much money you make from your investment. Because a higher expense ratio can significantly reduce the overall gains you get from the investment.

If the value of the ratio is too high, it can reduce your profit. Therefore, it is essential to keep an eye on this to ensure the maximum benefit from your investment.

For example, you are considering investing in two mutual funds that have the same returns of 10%. But one has an expense ratio of 1% and the other has an expense ratio of 2%. Then you will get a higher return from the first fund. Because you have to pay a larger portion of your return as a fee in the second fund. 

The impact of compounding 

As time goes on, this ratio starts to have a bigger effect. This is because of the power of compounding, which means reinvesting earnings to generate even more earnings. 

In other words, the longer you hold an investment, the more powerful compounding becomes. Therefore, the longer the investment period, the more noticeable the impact of the expense ratio on the overall return of your investment.

For example, if you invest Rs.10,000 in a mutual fund with an expense ratio of 1% and earn a return of 10% per year for 20 years, the final value of the investment will be Rs.67,275. But, if the ratio is 2%, the final value will be Rs.56,918. There is a difference of Rs.10,357.

How to choose mutual funds with low expense ratios?

To make the most out of their investments, you should opt for mutual funds that have low expense ratios. To determine this, you can look at the prospectus or check its website. It is important to compare the expense ratios of different funds to select the ones that have the lowest fees. 

Besides this, you must also take into account other factors like the performance of the fund, risk, and investment goals. By comparing these factors, you can make decisions that can potentially yield better returns on your investments.

The expense ratio is one of the factors you must consider when investing in mutual funds. Higher expense ratios can reduce the overall returns from your investment. If it is lower, then the fund is managed efficiently, and more of the returns will come to your pocket.