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What is TER (Total Expense Ratio) in Mutual Fund: How to Calculate TER

How is TER calculated in mutual funds? Here is all you need to know about total expense ratio (TER), its definition, meaning and importance. Read to know more.
78_What is TER in Mutual Fund_

Every mutual fund house has to incur some expenses to provide services to its investors. These expenses are, in turn, passed on to the investors in the form of a total expense ratio. In this article, we will understand what is TER (Total Expense Ratio) in mutual fund and how to calculate TER.

What is a total expense ratio?

For every mutual fund scheme, there are certain expenses associated with running the scheme. These expenses can be categorised as scheme advertising and marketing, administration and operations, transaction, customer servicing, etc. All these expenses related to running a mutual fund scheme are collectively categorised as the total expense ratio.

As per SEBI guidelines, the TER is charged as a percentage of the scheme's total assets under management (AUM). So, while evaluating a mutual fund scheme, you will see the TER as, say, for example, 1%. It means 1% of the scheme's total AUM will be charged as the TER for the scheme.

Components of TER in mutual fund

There are various components of the total expense ratio. Some of these include the following.

  1. Management fees: Involves the salaries of the fund manager, research team, and other staff members.
  2. Agent’s commission: Many mutual fund schemes are sold through intermediaries such as mutual fund distributors, broking firms, banks, etc. They are paid commissions on their sales. The commission is a part of the distribution expenses.
  3. Transaction costs: Includes the costs associated with buying and selling securities such as brokerage and Government levies.
  4. Administration costs: Includes shared expenses such as office rent, stationery, electricity, and other admin expenses.
  5. Legal and accountancy costs: Includes expenses related to compliance and other legal expenses, accounting and audit expenses, etc.
  6. Sales and marketing: Includes expenses related to advertising on television, newspapers, the internet, outdoor media, and other channels.

SEBI limit on TER

SEBI has issued guidelines on the maximum TER that mutual fund houses can charge. The TER is based on the following parameters:

  1. Type of scheme: The TER that can be charged varies as per the type of scheme. For example, the maximum TER that a scheme can charge for an equity scheme is higher than a debt scheme.
  2. Regular and direct plans: In the case of regular plans, a commission is paid to an intermediary. On the other hand, no commission is paid to an intermediary in direct plans. Hence, the TER for direct plans will always be lower than regular plans.
  3. Active and index funds: In the case of active funds, the fund manager decides which stocks to buy, how much to buy, and what price to buy. These decisions are taken based on the research team's data. Whereas in index funds, the fund manager has no such authority. The scheme money is invested in all the index constituents as per their weightage. Hence, the TER of an active fund is usually higher than that of an index fund.
  4. Scheme Assets under Management (AUM): The TER percentage is based on the scheme AUM. Every scheme will start with a lower AUM and a higher TER. As the scheme AUM increases, the TER that can be charged goes down.

SEBI limits for TER for equity mutual fund schemes

Assets under Management (AUM)TER limit
Rs. 0 – 500 crores2.25%
Rs. 500 – 750 crores2.00%
Rs. 750 – 2,000 crores1.75%
Rs. 2,000 – 5,000 crores1.60%
Rs. 5,000 – 10,000 crores1.50%
Rs. 10,000 – 50,000 croresFor every Rs. 5,000 crores increase in AUM, the TER goes down by 0.05%
Above 50,000 crores1.05%

Why do fund houses change TER frequently?

There are various reasons why fund houses change their TER. Some of these include:

  1. Change in AUM: We have seen in the above section, as per SEBI guidelines, as the AUM of a scheme increases from one slab to another, they have to reduce the total expense ratio (TER). So, as and when the scheme AUM increases, the fund has to reduce the TER. If there is a big fall in the market or the scheme faces heavy redemption, then with the decrease in AUM, the scheme can increase the TER.
  2. Market competition: The mutual fund industry is very competitive. All AMCs try to get investors to invest in their schemes. So, while SEBI has defined upper limits on what fund houses can charge as TER, fund houses usually try to keep their TER to the minimum to attract new customers. The common practice used by many AMCs is to launch a new scheme with the lowest possible TER. Once the scheme garners the targeted AUM, they increase the TER.

Most AMCs change the TER for their schemes either monthly or quarterly. The increase or decrease in the TER has to be made in compliance with SEBI guidelines on AUM slab-wise maximum limits.

Impact of expense ratio on returns

The TER is charged to the mutual fund scheme. Hence, the TER has a direct impact on the investor’s returns. For example, if a scheme has generated a return of 10% in a year, and the TER was 1%, then the net return for the investor will be 9%.

Calculation of TER in mutual fund

We have seen in the earlier section that the TER is charged as a percentage of the AUM. The following formula is used to calculate the TER:

Total expense ratio (TER) = (Total scheme expenses during a specified period / Total scheme assets) * 100

For example, a scheme had total expenses of Rs. 50 crores and an AUM of Rs. 5,000 crores. The TER calculation will be as follows:

(50 crores / 5,000 crores) * 100

= 0.01 * 100

= 1%

Key takeaways for investors

When choosing a particular scheme for investment, an investor should compare similar schemes from different AMCs. For example, if you wish to invest in a Nifty 50 Index Fund, you should compare Nifty 50 index schemes offered by various schemes. One of the comparison parameters should be the expense ratio. From an investor’s point of view, the general rule is, the lower the TER, the better, other things being equal.

Keep an eye on TER

As an investor, now that you understand what TER is and how it is calculated, make sure you check the TER of a scheme before finalising it for investment. Do remember that the TER directly impacts your returns. Hence, the lower the TER, the better. Once you start investing in a scheme, make sure you track the changes in the TER.
To start investing in mutual fund schemes with a low total expense ratio (TER), download the Glide Invest App from Google Play Store or Apple App Store and get started.

To read more on similar topics, click here:
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