PERSONAL FINANCE MUSING 32 ALL ABOUT TOTAL EXPENSE RATIOS OF MUTUAL FUNDS

PERSONAL FINANCE MUSING 32

ALL ABOUT TOTAL EXPENSE RATIOS OF MUTUAL FUNDS

Let me commence the post with two good news- first, that my book “Musings of a Financially Illiterate father” has been selected by Amazon to be featuring in their “Kindle Monthly Deals (KMD)” for the month of November 2018. The books featuring on KMD are selected by an internal algorithm of Amazon which takes into account the sales data of the book. The books are available at minimum 60% off and thus KMD turns out to be a win-win situation for both, the readers and the author. I will request to give wide publicity to this post for maximum people to benefit from this deal. The second news is that my book has risen to Rank 141 on Amazon “Business self-help books” and Rank 182 in Kindle amongst books on “personal development and self-help” (both ranks as on 11 Nov 2018). A huge honour indeed- for a debut author.

          Nearly all of us invest in mutual funds- equity or debt, which to my mind is the best way to invest in equity as I am quite against direct exposure to the stock market. As a common investor we lack the skill-sets and wherewithal to carry out deep research of nearly 7,000 stocks available in Indian equity market. Yes, we might at times get lucky and strike it rich in few stocks but our long-term financial planning should never be based on luck.

Anyway, returning to the subject of mutual funds, what we see on the prospectus of every mutual fund is an entity called “Total Expense Ratio (TER)”. TER broadly consists of the fund management fees, transaction costs, marketing costs, and distributor’s commission and is charged as a percentage of the investment being managed. Thus TER reduces your returns by the same percentage- for example; a TER of 2% will reduce a fund’s gross return from say 15% to 13%. It is a substantial cost to you and it is good to be mindful of it, let’s put this cost into perspective.

Firstly, TER is a percentage of the total investment being managed. So, if a fund charges a TER of 2%, for a total investment of Rs 1 lac, you are paying the fund house Rs 2,000 but when the investment corpus grows to Rs 10 lac, the fund house takes Rs 20,000 from you. The impact of TER thus gets more severe with a larger corpus.

Secondly, TER is a recurring charge which continues irrespective of the fund’s performance. If a fund is giving you a return of 15%, you may not mind paying 2% for it but if it has given you a loss of 10%, you definitely will feel bad paying 2% to the fund house. It will amount to paying for inefficiency from the existing corpus. This is not a theoretical construct as most mid cap and small cap funds have given negative returns this year.

Thirdly, The TER should be seen in the context of returns generated by the fund. If a fund has given returns of 10%, a TER of 2% is akin to returning 20% of your profits back to the fund house, which is substantial considering it is your money that the fund house is playing with. However, if the returns drop to 4%, a TER of 2% is akin to returning 50% of your profits to the fund house. In the scenarios of negative returns, the less said the better. So, as an investor you are putting up 100% of capital, taking 100% of investment risk and are paid 50% of profits.

All fund houses today are mandated to offer two types of schemes- regular and direct. In the direct scheme, you are not paying the fee for the advisor or distributor services and the TER is lesser by up to 1%. I have mentioned this issue in my trilogy of posts on “play with numbers” with examples. Please go through the post, the link is provided below.

https://andysfinancial.blogspot.com/2018/10/personal-finance-musing-30-play-with.html

To fathom as to how significant this 1% difference in cost could be, we will take an example. Let’s say you invest Rs 10,000 per month in an index mutual fund with an expense ratio of 0.2%. You start to invest at age 25 and continued till age 60 and in this duration, the fund returned 12% CAGR. This takes your corpus to Rs 6.1 crore. Had you instead invested in a direct plan of an equity mutual fund with an expense ratio of 1.5%, your corpus would have been only Rs 4.3 crore.

If you had gone for the same equity fund but a “regular plan” with an expense ratio of 2.5% your final portfolio value, with all other parameters remaining same would be barely Rs 3.3 crore. The above example once again shows the rupee draining power of costs. Hence one should always prefer an Index fund/ETF (adequately covered in my book) or else an active mutual fund with the least expense ratio.

That’s it for this week and as is customary an update on my book.  “Musings of a (financially) illiterate father- a common investor’s guide to wealth creation and retention is scaling new heights every day besides generating a buzz and having great sales.

The book (paperback) is currently available domestically on Amazon.in, Flipkart, Infibeam and Notion press, and internationally on Amazon.com and Amazon.co.uk. The e-Book version is available on Kindle, Kobo, i-books and Google Books.

I am happy to announce that the book is now also available in major bookstores in the country including English Book Shop, Chandigarh, Rathee Media Centre, Jodhpur, Arya Book Store, Udaipur and Akanksha Book Depot beside other.

I will urge you to continue to share this post too as my book has been specially written to teach the alchemy of wealth creation and retention to our children-they deserve to learn it. Please support this mission of financial literacy by reading and recommending this book. The link is given below.

https://www.amazon.in/Musings-Financially-Illiterate-Father-Investors/dp/1643247263?tag=googinhydr18418-21&tag=googinkenshoo-21&ascsubtag=2cd97bc1-4bb5-4954-8f55-6fbb7070d8b9

          For now, enjoy your Sunday while reading my book- you have earned it.