Expense ratio of most equity mutual funds are around 2 per cent per annum, which means the investor pays Rs 2 per Rs 100 invested on a yearly basis regardless of the rate of return. Is such a high rate of expense deduction justified?
Asset management companies manage investors' money and they charge a fee for this. They provide professional services like giving investment advice and incur costs in paying commission to distributors, ongoing service fee, legal and audit fee, registrar and transfer agent fee, marketing and selling expenses etc. The AMC charges an investor for all these expenses. All expenses combined together are called total expense ratio. It is an annual charge on the AUM. Equity mutual funds are allowed to charge expenses upto 2.5 per cent.
Apart from this, in its recent regulation SEBI has allowed fund houses to charge 30 basis points on inflows beyond the top 15 cities and 20 basis points additional expense in lieu of exit load. Also, now the service tax will be charged to the investors, which was earlier borne by AMCs. These costs have increased the expense ratio to 3.10 per cent.
Also, SEBI has allowed mutual funds to charge a transaction charge at Rs 150 from a first time investor and Rs 100 from existing investor if the investment amount is more than Rs 10,000. In case of SIP transaction charge will be levied where the total investment amount committed is more than Rs 10,000.
There are also certain indirect costs like in case of ETF an investor has to bear the cost of opening a demat account and brokerage charges for maintaining the account. Mutual funds are required to pay securities transaction tax for buying and selling stocks, these are in turn borne by the investor.
Therefore, an investor has to bear the cost if he wants to make investment in mutual fund, he can't avoid it but he can opt for a less expensive fund as lower the expense higher will be the returns and viceversa.