5 min read • Published 9 Jan 25
TER in Mutual Funds
Table of Contents
The total expense ratio (TER) is the total annual cost for managing and operating a fund. It includes different parts, such as management fees, the administrative expenses and the marketing costs. Total cost is represented by the % of total assets in TER. Usually, funds with higher Asset Under Management (AUM) have lower TER in mutual funds as the cost is divided across the funds. It can be one of the most crucial factors to consider while selecting the suitable mutual fund scheme. Therefore, understanding its meaning, formula, calculations and components is important for the investors.
What is TER in a Mutual Fund?
TER is the total expense indicating the cost of managing a mutual fund scheme, expressed in relation to the fund’s AUM. With this ratio, the investors can understand what part of their investment will be used for fund management. It is a part of Net Asset Value (NAV) of a scheme. The Securities Exchange Board of India (SEBI) has prescribed an upper limit for this charge in %. However, costs like exit loads and taxes are not included in this. They are based on the investor’s transaction.
How Does TER Work?
Management costs of mutual funds are reflected in a TER charge. It is a figure that is obtained by dividing the total of all assets owned by the fund by the total value of all of its assets. When the TER is subtracted daily, the fund companies declare the NAV or the Net Asset Value of the fund. The amount of returns that the fund is able to get is influenced by the TER in activity.
Formula:
Total Expense Ratio = (Total Expenses Incurred / Total Fund Assets) x 100
The total expense ratio (TER) can affect the returns on investment (ROI) of the fund. Therefore, when assessing the fund, it is necessary to look at the TER in Mutual Funds. Understand it with this hypothetical example:
Suppose, an investor invests ₹15 lakhs in mutual funds. The fund incurred an administrative expenses of ₹10,000, paid management fees of ₹20,000 and other expenses of ₹5,000 per annum.
The TER would be calculated as follows:
Total Expenses = Administrative costs + Management fees + Other expenses
= 10,000+20,000+5,000
= ₹35,000
TER = Total Expenses/ Total Assets = 35,000/ 15,00,000 = 0.0233 or 2.33% of investment
Compared to passive investment funds, actively managed funds have a higher TER %. Increased transaction costs and research expenses directly affect the increase in effort of the active fund managers. Therefore, it affects the TER in active mutual funds. Passive funds only seek to copy the returns of index funds, which attracts lower TERs compared to active funds.
Importance of TER in investments
An expense ratio can be a crucial factor affecting the final investment returns for an investor. The total returns will reduce as the TER increases. Here’s an example to help you understand:
Assume that the fund generates returns of 1% every day. Then the calculation breakdown looks like this:
| Days | Investment Value | Daily Expenses | Net Value After Expenses | Daily Returns |
| Day 1 | 1200 | (1200*0.5%/365) = 0.016 | 1199.984 | (1% of 1199.984) = 11.99 |
| Day 2 | 1200 + 11.99 = 1211.99 | (1211.99*0.5%/365) = 0.0166 | 1211.82 | (1% of 1211.82) = 12.11 |
| Day 3 | 1211.99 + 12.11 = 1224.1 | (1224.1*0.5%/365) = 0.0167 | 1223.93 | (1% of 1223.93) = 12.23 |
| Day 4 | 1224.1 + 12.23 = 1236.33 | (1236.33*0.5%/365) = 0.0169 | 1236.31 | (1% of 1236.31) = 12.36 |
Notes: The Calculation is for Illustrative purposes only.
When selecting the type of fund to invest, it is important to note that cost ratio is only one aspect of the investment. Other factors affecting the suitable fund selection can be asset allocation, portfolio manager, fund house, market situation, etc.
Costs Involved in Mutual Fund TER:
TER in Mutual Funds includes multiple fees. Some are recurring, and others only are to be paid once. These are crucial for the fund’s continued operation. Listed here are the most important ones:
1. Cost of Management
All things considered, this is one of the calculation’s most significant fees. All of the fees that the fund manager gets for his services are part of it. This charge covers the investing team and fund managers’ salaries.
2. Cost for Administration
In the course of running the mutual funds on a daily basis, these expenses are incurred. Bookkeeping, accounting, operational, and other related costs constitute the bulk of the total. It also covers normal office expenditures and registration fees.
3. The Cost of Advertising and Distribution
This charge is known by several names, one of which is 12B-1. The fees associated with selling and promoting mutual funds are part of this. Expenses paid to agents for the money include advertising, marketing, commissions to brokers, promotional costs, and more.
4. Maintenance Fee
It incorporates all costs that are incurred to maintain operations. Expenses like customer service charges, exit load, and record-keeping costs are all part of this. To keep operations running smoothly and provide excellent customer service, this charge is necessary.
5. Booking Fee
This is the amount that the fund pays to finance the purchase and sale of assets in its portfolio. Fees paid while buying and selling stocks, bonds, and other investments are a common example.
6. Attorney Fees
All of the expenses associated with hiring the experts are included in this. Legal expenses and audit fees make up the bulk of it. Independent auditors get their cut of the audit costs, while mutual funds incur continuous legal expenses in the form of legal fees.
7. Other Costs
Additional miscellaneous expenditures consist of payments made to third-party service providers, such as rent, power, and technology charges. These are crucial for the TER in Mutual Funds to continue functioning.
Conclusion
Mutual fund TER can be expressed as the total cost incurred by the fund house for managing and operating a mutual fund scheme. The returns of the fund are directly affected by TER in Mutual Funds. Usually, active funds have higher TER than the passive ones. Regulatory bodies have prescribed a ceiling for TER % based on the AUM of the fund house. Understanding what TER is in mutual funds and selecting the fund with potentially lower cost can help investors in the long run.
Q: What Is Ter In Mutual Fund?
A mutual fund's TER, or Total Expense Ratio, shows how much money the fund has spent on running and managing its assets relative to those assets.
Q: How are AMC and TER different?
Mutual fund management firms are known as asset management companies (AMCs), whereas the Total Expense Ratio (TER) measures the management fee as a proportion of the fund's assets.
Q: What does TER stand for in regard to NAV?
There is a negative correlation between the TER and the NAV. Before determining the NAV, the entire assets of the fund are subtracted from the costs, as recorded by the TER.
Q: How much of a total expense ratio is considered acceptable?
The definition of an "acceptable" total expense ratio for different types of funds varies. The expense ratios (TERs) of actively managed funds can reach 2% or higher, in contrast to the lower TERs of index funds and exchange-traded funds (ETFs), which range from 0.1% to 0.5%.
Q: What are TER's limitations?
Expenses like exit loads and taxes are not factored into TER, which can be its limitations. Moreover, it may not match the performance of the fund as lower TER is does not firmly indicate higher net returns.
