How to maximize returns by minimising costs

It seems sometimes that online grocery and food delivery platforms take some sadistic pleasure trying to give you a false sense of accomplishment about saving money. For example, a few days ago I got a rare opportunity - a Rs 200 off coupon, free delivery, and exclusive 50 per cent off (up to Rs 100). I carefully selected items that I needed, and items I did not need, to make sure to hit the minimum spend amount for all the discounts.

I expected to feel proud about my frugality, except the final payment was a mere Rs 10 lesser than the original amount. There are hidden charges - like 'convenience fees' and 'packing charges' - these platforms don't show while tallying the number of items in your cart that negate the effects of any benefits these platforms provide. Why was I buying things I did not need just to feel like I was saving money? Here's the point of this analogy - all services carry with them some hidden charge, mutual funds included. The issue arises when people start equating higher charges with better services.

As investors, it is important to understand that the cost should reflect the service and not the other way around. Just because something costs more doesn't mean it is better.

Let's discuss how to not let numbers take an advantage of you by understanding what expense ratios are and how they work.

Who pays for mutual fund services? You.

Just like restaurants charge you for service, mutual funds charge you for management. The convenience of having a professional handle your investments isn't free. The charge is called the expense ratio , which is the percentage of your investment that goes toward operational costs.

Asset Management Companies (AMCs) hire fund managers, analysts, and support teams to research, trade, and manage funds. They also have expenses like technology, compliance, and marketing. Who covers these costs? You and other investors like you.

Regulated by SEBI, expense ratios typically range from 0.05 per cent to 2.25 per cent. Not all funds charge the same, and more expensive doesn't always mean better. The key is ensuring you're getting value for what you're paying. Let's break down how these costs can silently drain your wealth over time.

Suggested read: Mind your expenses

How expense ratios silently kill your wealth

Let's look at a hypothetical scenario that is actually quite common for investors. You are presented with two funds: Fund A and Fund B. Let's assume that both funds will deliver an 8 per cent annual return. The funds are both seemingly the same but the expense ratio of A is 0.5 per cent while that of B is 2 per cent. What is it about Fund B? Why are the expenses higher? Is it because they have some hidden trick up their sleeve that ensures they'll perform better? That has to be it. You decide to take the chance and start a Rs 10,000 monthly SIP.

Here's how the chance panned out.

How is the difference so much even though the ratios differed by a mere 1.5 per cent? Just like your compounding snowballs your returns, it also snowballs your expenses. Think of compounding like a rolling coin. On one side is the heavenly return and on the other side is the evil expense. They don't exist without each other.

In such a scenario, one thing you can do is ask 'why?' Why is there a difference in expenses between two similar funds? Why do you think the one that costs more is better? While the answer for the former might vary, the reason for the latter can be explained by the placebo effect of pricing. This occurs when a higher price leads you to believe a product is better, even compared to the same product with a discounted price. The first step to beat such a bias is to be aware of it.

Now let's discuss other ways you can stop yourself from paying high prices - at least when it comes to mutual funds.

Minimize costs and maximise returns

Lowering expenses is the easiest way to boost your returns, no extra risk required. Here's how you do it:

• Choose funds with lower expense ratios : Always compare funds before you invest. For instance, passive funds generally have lower fees than actively managed ones.
  
• Avoid high-turnover funds : Funds that frequently buy and sell stocks rack up trading costs. Look for funds with a stable, long-term approach.
  
• Go for direct plans : Regular plans include distributor commissions. Direct plans cut out the middleman, reducing costs significantly. Try investing directly through the fund house.
  
• Review your portfolio annually : Expense ratios change. Make sure you're not paying more than necessary for underperforming funds.

Small changes make a big difference over time. Lower costs mean more money stays invested - money that will end up in your pocket.

Suggested read: How to switch from a regular plan to a direct plan

How SEBI has your back

You don't have to think of yourself as a novice fending yourself against a pack of feral wolves with finance degrees. SEBI hands you a flaming torch by setting in place stringent rules that make investing more favourable towards investors. Some of these rules include:

• No entry loads : Mutual funds cannot ask you to pay an upfront fee to invest.
  
• Capping expense ratios : While the amount depends on assets under management (AUM), the maximum amount of expense that a mutual fund can ask you is 2.25 per cent.
  
• Complete transparency : Mutual funds are obligated to give you a breakdown of expenses.

Remember, while you have a torch, it is up to you how to use it. It works best to always stay alert and do your research before you invest and pay high fees.

Key takeaway

The less you spend on hidden costs, the more you invest in you. High expenses don't equal high returns; they just make someone else rich. Take charge, choose wisely, and make sure every rupee you invest is actually working for your financial success.

Also read: A simple financial framework to build wealth

This article was originally published on March 19, 2025.