Mutual Fund Expense Ratios: The Shocking Truth Experts Don't Want You To Know
- Utpal KC
- Mar 20
- 4 min read
Updated: Mar 22
Are you blindly following the advice to choose mutual funds based on their expense ratios? You might be missing out on bigger gains! Too often, investors focus solely on this one metric, potentially overlooking funds that could significantly boost their returns.
Utpal KC, a former equity analyst for institutional investors, proprietor of Utpal KC Wealth, and founder director of Saintwords Solutions Pvt Ltd, is here to set the record straight. With years of experience in the finance industry, Utpal debunks the myth that a low expense ratio is the most important factor when choosing a mutual fund. Get ready to rethink your investment strategy!
What is an Expense Ratio?
The expense ratio is the percentage of your investment that a mutual fund uses to cover its operating expenses. Think of it as the cost of having professionals manage your money. It covers the fund manager's salary, research costs, and other administrative fees. So, why is everyone so obsessed with it?
The Tea House Analogy: Value Over Cost
Imagine you find a tea that smells and tastes amazing. Would you refuse to buy it just because the tea house makes a good profit? Of course not! You're paying for the experience and the quality of the tea.
Similarly, don't reject a high-performing fund solely because of its expense ratio. The value you receive – the fund's performance – is more important than the cost (expense ratio) in isolation. Are you getting a good return on your investment? That's what truly matters.
The NONSENSE of Choosing Funds Solely on Expense Ratio
Why is it so wrong to focus only on the expense ratio? Here's the deal:
Good Management Costs Money
Skilled fund managers and experienced research teams don't work for free. They command higher salaries because they deliver results. A higher expense ratio can indicate that the fund invests in top talent, which can lead to better performance.
Are you willing to pay a little more for expertise that can generate higher returns? It's like hiring a professional versus doing it yourself. Sometimes, the extra cost is worth it.
Real-World Examples
Let's look at some real-world examples to illustrate this point. Keep in mind that the data is a few weeks old, but the principle remains the same.
Example 1: Infrastructure Funds
Fund | Expense Ratio | 3-Year Return |
Fund A (Example: L&T) | 0.58% | 25.3% |
Fund B (Example: Invesco) | 0.79% | 23.74% |
Fund C (Example: ICICI Pru) | 1.15% | 27.8% |
As you can see, Fund C has the highest expense ratio but also the highest return. Fund B has the lowest return, despite having a lower expense ratio than Fund A. What does this tell us?
Example 2: Midcap Funds
Fund | Expense Ratio | 3-Year Return |
Fund D (Example: Axis) | 0.39% | 22.7% |
Fund E (Example: Motilal Oswal) | 0.65% | 29.8% |
Again, Fund E has a higher expense ratio and significantly outperforms Fund D. This reinforces the idea that there's no direct link between expense ratio and performance.
Key Takeaway: Focusing solely on the expense ratio can lead you to miss out on potentially higher returns. Don't let a small percentage prevent you from making a smarter investment.
Addressing the Influencers and Trainers
So, why do some financial influencers and trainers focus so much on expense ratios? Utpal explains that often, it's because they lack a deep understanding of how expense ratios are calculated and what truly drives fund performance. They might be repeating information they found online without truly understanding it.
Be wary of generic advice. Always do your own research, consider your individual financial goals, and look at the bigger picture.
How Expense Ratios Are Actually Calculated
Let's break down how expense ratios are calculated. It's simpler than you might think! This is a simplified example, but it will give you a general idea.
Assumptions:
Number of Units: 1 Lakh (100,000)
Assets Under Management:
Shares (Market Value): ₹20 Lakhs
Bonds: ₹1 Lakh
Cash: ₹1 Lakh
Short-Term Loan: ₹-2 Lakhs
Total Assets: ₹20 Lakhs
Expense Ratio: 1.5% per year
Trading Days: 250
Calculations:
Daily Expense Deduction: (Total Assets * Expense Ratio) / Trading Days
(₹20 Lakhs * 1.5%) / 250 = ₹120
Net Total Assets (Post Expense): Total Assets - Daily Expense Deduction
₹20 Lakhs - ₹120 = ₹19,99,880
Net Asset Value (NAV): Net Total Assets / Number of Units
₹19,99,880 / 1 Lakh = ₹19.9988
Here's the key point: The expense ratio is already factored into the NAV (Net Asset Value) of the fund. When you buy a unit, you're buying it after the expenses have been deducted. Worrying about the expense ratio after that point is unnecessary!
The Appreciation Example
Let's say the market does well, and the fund's assets increase.
Shares (Market Value): ₹30 Lakhs
Bonds: ₹1.2 Lakhs
Cash: ₹5,000
Short-Term Loan: ₹-8,000
Total Assets: ₹31.33 Lakhs
The NAV will increase accordingly. The appreciation is what matters to you as an investor. If the NAV increases from ₹19.9988 to ₹31.3281, that's a 56.65% appreciation! That's what you should be concerned with, not the initial expense ratio.
Beyond Expense Ratio: What Should You Focus On?
So, if not expense ratio, then what?
Risk-Adjusted Return
It's not just about how much a fund returns, but how much risk it takes to achieve those returns. A fund that generates high returns with excessive risk might not be the best choice.
Key metrics to consider include Alpha, Beta, Sharpe Ratio, Sortino Ratio, Standard Deviation, and R-squared. These are more advanced concepts, but understanding them can significantly improve your fund selection.
Market Valuations and Portfolio Management
Understanding market valuations and having a sound portfolio management strategy are crucial for long-term success. Don't just chase the highest returns; build a well-diversified portfolio that aligns with your risk tolerance and financial goals.
For a deeper dive into these concepts, consider checking out Utpal KC's resources and courses. He provides detailed explanations of portfolio management and risk analysis.
The NEXT Big Trap: Chasing Returns!
Thinking that the fund with the highest return is always the best choice? Think again! In the next video, we'll expose the dangers of solely chasing returns. Subscribe to stay tuned!
This blog post is for informational purposes only and not financial advice. Consult with a qualified financial advisor before making any investment decisions.
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