The expense ratio: the small number that quietly shapes your returns
A 1% yearly fee sounds tiny. Over 20 years it can cost lakhs. How a mutual fund's expense ratio works, and why direct and regular plans differ.
Every mutual fund charges a fee for running your money. You never pay it as a separate bill. Instead, it is taken out of the fund’s assets, a little each day, and shows up only as a slightly lower NAV. That invisibility is exactly why the expense ratio deserves a closer look.
What the expense ratio is
The total expense ratio (TER) is the annual cost of running a scheme, expressed as a percentage of its assets. It covers the fund house’s management fee, administration, registrar and custodian costs, marketing and, in regular plans, the commission paid to distributors.
If a fund has a TER of 1% and holds ₹100 crore, roughly ₹1 crore a year goes to these costs. The charge is accrued daily, so the NAV you see is already net of expenses. The returns a fund publishes are also after expenses.
SEBI sets maximum TER limits, which vary by fund type and size. These limits have been revised over time, so check the current rules on the SEBI website rather than relying on old figures. Each fund house must publish its schemes’ TERs on its website, and AMFI’s site gathers them too.
Direct vs regular plans
Since 2013, every mutual fund scheme in India has offered two versions:
- Regular plan: bought through a distributor, bank or agent. Part of the TER pays their commission.
- Direct plan: bought straight from the fund house or through a platform that doesn’t take commission. No distributor commission is built in, so the TER is lower.
Both plans hold the same portfolio, managed by the same fund manager. The only difference is the cost, and therefore the return. Because of this, the two plans have different NAVs.
Regular plans aren’t wrong in themselves. If a distributor genuinely helps you pick suitable funds and stops you from panic-selling, that service has value. But you should know what you’re paying for it.
A worked example (assumed numbers)
Suppose a fund’s portfolio earns 12% a year before costs — an assumption for illustration, not a forecast. Assume the regular plan’s TER is 1.8% and the direct plan’s is 0.8%. These are made-up figures chosen to show a 1 percentage point gap.
Net returns are then roughly 10.2% (regular) and 11.2% (direct).
One-time investment of ₹10 lakh:
| Years | Regular plan (10.2%) | Direct plan (11.2%) | Gap |
|---|---|---|---|
| 10 | ₹26.4 lakh | ₹28.9 lakh | ₹2.5 lakh |
| 20 | ₹69.8 lakh | ₹83.6 lakh | ₹13.8 lakh |
SIP of ₹10,000 a month for 20 years (₹24 lakh invested in total): about ₹74 lakh in the regular plan against about ₹84 lakh in the direct plan — a gap of roughly ₹10 lakh.
Notice how the gap widens with time. In year one, the difference on ₹10 lakh is only about ₹10,000. By year 20, it is more than the original investment. That is compounding working against you: every rupee paid in fees also loses all the future growth it would have earned.
Expense ratio is not everything
A low cost is a reliable advantage, but it is not the only thing that matters:
- Compare like with like. Index funds usually have lower TERs than actively managed funds because they don’t pay for research and stock-picking. Comparing a small-cap fund’s TER with an index fund’s tells you little.
- Look at returns net of costs over long periods, against the fund’s benchmark.
- Watch for exit loads and taxes. Switching from a regular to a direct plan counts as a redemption and a fresh purchase, which can trigger an exit load and capital gains tax. Sometimes it is better to stop new money going into the regular plan and switch gradually.
What to do
- Check which plan you hold. Your account statement or the scheme name will say “Direct” or “Regular”.
- Look up the TER on the fund house or AMFI website, and note how it compares with similar funds.
- For new investments, consider the direct plan if you are comfortable choosing funds yourself.
- If you want advice, a SEBI-registered investment adviser charges a separate fee and can recommend direct plans — the cost is visible rather than hidden.
- Before switching existing holdings, work out the exit load and tax impact first.
For more on investing methods, read SIP vs lump sum, or look up unfamiliar terms in our glossary.
Mutual fund investments are subject to market risks. This article is educational and is not a recommendation. Consider speaking with a SEBI-registered investment adviser.
This article is for education only, not personalised investment, tax or legal advice. Rules and rates change. Check the latest official sources or a qualified professional before acting. Spotted an error?Tell the editor.
