Pay attention to the Mutual Fund expense ratio. Think of it as a cost of holding a MF investment. This is charged to you irrespective of the fund’s performance. And it can have a big impact on the overall return you get from your investment.
Expense ratio explained
Usually expressed as a percentage of assets, this is the money you pay each year to the fund house for managing your money. You do not pay this fees directly. The fund house will deduct this amount from your investment. For actively managed funds, the expense ratio is around 2%. This means that you as a investor pay around Rs 2000 for every lakh invested in a fund.
Impact on your return
Expense ratio can make a huge difference on the return you get. To illustrate, I have considered a case you have invested 100,000 in a MF that generates 10% return each year before expenses. Now you can see impact on total return you make at the end of 10 years.
As you can see, if you pay 2.5% as expense as compared to 0.5%, then you end up making 41700 less over 10 years. This amount is not trivial considering you only made 1 lakh in return for investing for 10 years.
Mutual Funds with low ratio
Does this mean that you should buy Mutual Funds with low Expense Ratio? It depends. While it is an important factor in deciding the mutual fund but not the only one. If a Fund is generating alpha consistently, it deserves slightly higher expense ratio. On the other hand, a low performing fund with low expense ration is also not good.
An important thing to consider is how the expense ratio compares with category average.
In my opinion, expense ratio is one of the top 5 factors that one should look at while investing in a mutual fund.