What is TER (Total Expense Ratio) in Mutual Fund: Meaning & Full Form

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What is TER (Total Expense Ratio) in Mutual Fund: Meaning, Impact & Limitations

Investing in mutual funds is a popular way to diversify your investment portfolio. However, it's critical to understand the costs associated with mutual funds, as these can significantly impact your returns. One crucial cost element that every investor should know about is the Total Expense Ratio (TER). So, let’s uncover this cost in detail.

What is TER in Mutual Funds?

TER full form is the Total Expense Ratio. It is a key metric in the mutual fund industry. It symbolises the overall costs associated with managing and operating a mutual fund. Expressed as a percentage, TER in mutual funds reflects the proportion of a fund's total assets used to cover various expenses.

The costs encapsulated in TER are wide-ranging, encompassing management fees paid to fund managers for their expertise, administrative costs related to record-keeping, customer service, and other back-end operations, and other operational expenses such as audit fees, legal fees, and marketing costs.

Note that TER provides an inclusive picture of a fund's cost burden, ultimately impacting the net returns available to investors. A lower TER often means higher net returns for investors, all else being equal.

Total Expense Ratio Meaning

The Total Expense Ratio (TER) meaning plays a significant role in mutual fund investments. It measures the total costs of managing and operating a mutual fund, expressed as a percentage of its assets.

When the TER is lower, a larger portion of the fund's assets is invested to generate returns for the investor. This could lead to better investment performance, as more money is being put into work.

On the other hand, a higher TER implies that a larger chunk of the fund's assets is being used to cover expenses. This can reduce the net returns to the investors as the costs incurred by the fund eat into the profits.

So, understanding the impact of TER on your mutual fund returns is key. It allows you to choose lower-cost funds, optimising your potential returns. So, when selecting a mutual fund, consider the TER and its potential impact on your investment returns.

Major Costs that Add Up to TER in Mutual Funds

The Total Expense Ratio (TER) measures the costs of managing and operating an investment fund. It's a key indicator of the efficiency of a fund's operations and can directly impact an investor's returns.

Here are the main components of the TER:

Management Fees: These fees form a significant portion of the TER. They are payments made to the team responsible for making investment decisions and managing the assets in the fund.
Administrative Costs: These costs cover the fund's operational expenses. They include expenses like office maintenance, technology costs for managing the portfolio, and other related overheads.
Marketing and Distribution Expenses: This component covers the costs of promoting the fund and selling its units to investors. It includes advertising expenses and commissions paid to brokers and agents who sell the fund's units.
Other Operational Costs: This category covers a range of expenses necessary for the daily operations of the fund. It includes legal fees, auditor fees, and other miscellaneous costs not covered under the other categories.

Each of these components contributes to the overall TER of a mutual fund. Understanding these components and how they impact the TER can help you make more informed investment decisions as an investor.

How the Total Expense Ratio (TER) Works?

Calculating TER is straightforward: dividing the fund's total expenses by its total assets and expressing the result as a percentage.

Example

To illustrate, consider a mutual fund in India with total assets of Rs. 100 crore and total expenses are as follows:

Sales and marketing expenses: Rs. 35 lakh
Administration costs: Rs. 40 lakh
Legal and accountancy fee: Rs. 30 lakh
Other operational expenses: Rs. 10 lakh

Thus, the total expenses are Rs. 1.15 crore, leading to a TER of 1.15% (1,15,00,000/100,00,00,000).

SEBI Limit on TER in Mutual Funds

The Securities and Exchange Board of India (SEBI) has established a regulatory framework for the total expense ratio (TER) that mutual funds can impose. This framework is designed based on the assets under management (AUM) category and the specific type of fund:

For Equity Funds:

The TER can be up to 2.25% for the initial Rs.500 crore of net assets,
It can then be up to 2.00% for the subsequent Rs.250 crore, and so forth.

For Debt Funds:

The TER can be up to 2.00% for the initial Rs.500 crore of net assets,
It can then be up to 1.75% for the subsequent Rs.250 crore, and so forth.

Under the new regulations:

=The maximum TER for an equity scheme at the Asset Management Company (AMC) level can be up to 2.55%, applicable for AMCs within the first AUM slab (up to Rs. 2,500 crore).

What is the Impact of TER on Returns in Mutual Funds?

The effect of TER on mutual fund returns can be considerable over time. For example, two funds may have similar gross returns, but the one with a lower TER will provide higher net returns to its investors.

For instance, if a fund with a TER of 1.15% earns a return of 10%, the net return, after expenses, will be 8.85% for the investor.

Limitations of the Total Expense Ratio (TER) in Mutual Funds

Incomplete Picture: TER does not account for transaction costs incurred by trading securities within the fund's portfolio.
Lack of Transparency: Investors might find it challenging to discern how each component of the TER is charged.
Difficulty in Comparison: Comparing TERs across mutual funds can be misleading if the funds have different strategies and cost structures.

Conclusion

While TER is crucial in selecting mutual funds, it's not the only consideration. Investors should also examine the performance track record, the fund manager's expertise, and investment strategy. However, understanding TER and its impact on returns is fundamental for making informed investment decisions.

Frequently Asked Questions

What is the impact of TER on mutual funds?

TER directly reduces the fund's returns to the investor. A higher TER means higher costs and, consequently, lower net returns.

What is the effect of the expense ratio?

The expense ratio affects the overall profitability of the investment. Lower ratios generally translate to higher profits for the investor.

Should the total expense ratio be high or low?

Ideally, the total expense ratio should be as low as possible to maximise the returns to investors.

What is TER in mutual funds?

TER in mutual funds represents the total percentage of the fund's assets spent on various expenses, offering a clear picture of the investment's cost.