When you invest in a mutual fund, a small percentage of your money goes towards managing the fund. This is called the expense ratio. While it may look like a tiny number, it can have a surprisingly large impact on your returns over time.

In this post, we break down what the expense ratio is, what it includes, and how to use it while choosing a mutual fund.

What is an Expense Ratio?

The expense ratio is the annual fee that a mutual fund charges its investors to cover operating costs. It is expressed as a percentage of the fund’s average assets under management (AUM).

For example, if a fund has an expense ratio of 1.5%, it means that for every ₹1,00,000 you have invested, ₹1,500 per year goes towards fund management costs.

This fee is not charged separately. It is deducted directly from the fund’s returns before the NAV (Net Asset Value) is calculated. So when you see a fund’s NAV going up or down, the expense ratio has already been accounted for.

What Does the Expense Ratio Include?

The expense ratio covers several costs involved in running a mutual fund:

• Fund manager’s fees — Compensation for the team that manages the portfolio
• Administrative costs — Record-keeping, customer service, account statements
• Marketing and distribution expenses — Costs to promote and sell the fund
• Custodian and audit fees — Safekeeping of assets and regulatory compliance
• Registrar and transfer agent (RTA) fees — CAMS and KFintech charges for processing transactions

All of these are bundled into one number — the expense ratio.

How is It Calculated?

The formula is straightforward:

Expense Ratio = Total Fund Expenses ÷ Average AUM

If a fund has total annual expenses of ₹10 crore and average AUM of ₹1,000 crore, the expense ratio would be:

10 ÷ 1000 = 0.01 = 1%

SEBI (Securities and Exchange Board of India) sets upper limits on how much a fund can charge. As of current regulations:

As the fund’s AUM grows, the allowed expense ratio decreases in slabs — larger funds must charge less.

Why Does the Expense Ratio Matter?

A difference of even 0.5% in expense ratio can make a significant difference over 10, 20, or 30 years. Here is an illustration:

Suppose you invest ₹10,00,000 for 20 years and the gross return is 12% per year.

The difference between 0.5% and 2.0% expense ratio is roughly ₹22 lakh over 20 years on a ₹10 lakh investment. That is a massive gap — and it comes entirely from fees.

Direct Plans vs Regular Plans

One of the easiest ways to reduce the expense ratio is to invest through direct plans instead of regular plans.

• Regular plans include a commission paid to the distributor or advisor who sold you the fund. This commission is built into the expense ratio.
• Direct plans remove this commission, resulting in a lower expense ratio — typically 0.5% to 1% lower.

Over long holding periods, this difference compounds significantly. If you are comfortable selecting funds on your own, direct plans offer better value.

What is a Good Expense Ratio?

There is no single “good” number because it varies by fund type:

• Index funds and ETFs: Look for expense ratios below 0.5%. Many charge as low as 0.1% to 0.2%.
• Actively managed equity funds: Anything below 1.5% (direct plan) is reasonable. Below 1% is excellent.
• Debt funds: Expense ratios should ideally be below 1% for direct plans.

The key rule: lower is better, but not at the cost of fund quality. A well-managed fund with a 1% expense ratio that delivers strong risk-adjusted returns is better than a poorly managed fund with a 0.5% expense ratio.

How to Check a Fund’s Expense Ratio

You can find the expense ratio in these places:

1. Fund factsheet — Published monthly by the AMC
2. AMC website — Under the scheme details section
3. AMFI website — Provides expense ratio data for all mutual funds
4. Investment platforms — Most apps and platforms display this alongside other fund details

It is worth checking this number periodically, as expense ratios can change when SEBI updates regulations or when a fund’s AUM changes significantly.

Key Takeaways

• The expense ratio is an annual fee deducted from your fund’s returns, not charged separately
• Even small differences in expense ratio compound into large differences over time
• Direct plans have lower expense ratios than regular plans
• Index funds and ETFs typically have the lowest expense ratios
• Always compare expense ratios when choosing between similar funds
• SEBI regulates the maximum expense ratio that funds can charge

Understanding the expense ratio helps you make more informed investment decisions. It is one of the few factors in investing that is entirely within your control — you cannot control market returns, but you can choose funds that charge less to manage your money.