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The total expenditure ratio (TER) is a metric for the overall expenses incurred in running and administering an investment fund, like a mutual fund. These expenses include management fees and supplementary costs, including trading fees, legal fees, auditor fees, and other expenses of an operational nature.
To derive percentage amounts corresponding to the TER, the fund's overall cost shall be divided by the actual assets of the Fund. The net or after-reimbursement cost ratio is also the total expense ratio. Let’s move ahead to understand the total expense ratio in detail.
Understanding Total Expense Ratio In Mutual Fund
The total expense ratio determines how much it costs to manage the fund overall. Asset management firms, or AMCs, are in charge of managing mutual funds. As they manage the funds, they incur various costs. It covers administrative charges, transaction fees, marketing and sales expenditures, audit fees, custodian fees, and registrar fees. The Fund's Total Expense Ratio refers to all these costs.
How Does Total Expense Ratio Work?
For the fund's management, a total expense ratio shall be charged. It helps AMCs to recover costs relating to the administration of the scheme. It is charged on a percentage basis of the overall scheme's assets. After deducting the total expense ratio daily, fund houses shall declare the Fund's Net Asset Value.
TER will greatly influence the total return of your investment from the mutual fund. The costs increase as TER increases. This has an impact on the returns of the fund. In assessing the performance of a mutual fund, it is therefore appropriate to consider TER. For example, The net profit for the investor will be 19.75% in any plan with a 22% return and an expense ratio of 2.25%. Compared to passive funds, actively managed funds have a relatively high TER.
Fund managers are subject to frequent buying and selling of securities to take advantage of market opportunities since they operate actively. These frequent purchases and sales lead to significant transaction costs. Moreover, too much research must be done to purchase and sell so frequently. This increases the management costs as well. On the other hand, passive funds generally have little or no buying and selling of securities because they must replicate an index's performance to achieve a lower TER.
Formula And Calculation Of Total Expense Ratio
The total expense ratio is determined by dividing the mutual fund's expenses by its total assets. Here is the equation:
Total Expense Ratio = (Total Expenses Incurred / Total Fund Assets) x 100
Let’s consider an example for understanding the total expense ratio;
The total cost of managing the fund shall be stated in terms of all costs incurred. It covers administration costs, audit expenses, transaction costs, legal and accounting fees, sales and marketing expenditures or any other operational cost. The total amount of the fund's assets indicates the market value of all the stocks and bonds the fund holds on a given date.
Suppose you've got the following details in your investment fund:
The total costs of the XYZ equity fund for the year are Rs. 5,00,000. Total Assets Under Management for the year are as follows:
- Beginning AUM on April 1, 2023: Rs. 50 crore
- Ending AUM on March 31, 2024: Rs. 60 crore
- Average AUM = (Beginning AUM + Ending AUM) / 2
- Average AUM = (Rs. 50 crore + Rs. 60 crore) / 2 Average AUM = Rs. 55 crore
Now, we can use the formula to calculate the Total Expense Ratio (TER):
- TER (%) = (Total Expenses / Average AUM) x 100
- TER (%) = (Rs. 5,00,000 / Rs. 55 crore) x 100
- TER (%) ≈ 0.9091%
So, in this simplified example, the Total Expense Ratio (TER) for the XYZ Equity Fund for that year is approximately 0.9091%. This means that the Fund spent an amount amounting to approximately 0.891% of its average assets under management during the year.
Impact Of Total Expense Ratio In Mutual Funds
As an investor, TER may directly impact returns if they are actively managed Mutual Funds. The higher the TER cost to the investor, the lower the returns. The funds under management can, however, further impact this. However, the TER directly impacts the Net Asset value of investments. The comparison of individual TERs is necessary for analysing Mutual Fund benefits.
Limitation Of Total Expense Ratio
Several changes not covered by the TER, for instance, securities transfer tax, stockbroker fees, commissions and annual advisor's fees, will be treated as investment capital instead.
In selecting a mutual fund scheme, other factors are important, such as the track records of funds and their predictability of return, TER, or the total expenditure ratio. Research and analysis of the various options available to investors in a specific Mutual Fund, whether via the Internet or offline, are very important. The total expenses ratio is the overall operating expenses ratio that investors use for comparing costs and analysing the returns of a scheme. Achieving high returns from funds consistently showing a high TER is impossible, so be selective when investing. You can check out the Share India Trading Platform for more details in the stock market.