When investing in mutual funds, many people check the past performance, star ratings, or which AMC (Asset Management Company) manages the scheme. However, few give enough attention to something equally important: the Total Expense Ratio (TER).
What is TER?
The total expense ratio india (TER) is the annual fee charged by a mutual fund to manage your investments. It is expressed as a percentage of the fund’s average assets under management (AUM).
Think of TER as the “maintenance fee” of your investment. Just like a car owner pays for servicing, fuel, and insurance to keep the car running, mutual fund investors pay TER to cover the costs of running the scheme.
What does TER include?
- Fund Manager’s Fee: Salary and performance-linked pay for managing your money.
- Research Costs: Analyst team, databases, and market research tools.
- Transaction Costs: Brokerage, stamp duty, and taxes on buying/selling securities.
- Operational Costs: Custodian, registrar, audit, and legal charges.
- Distribution Expenses: Commissions to distributors (in regular plans).
For instance, if you invest ₹50,000 in a fund with a TER of 1.2%, you pay about ₹600 per year as expenses. This amount is not directly billed to you; it is deducted from the scheme’s NAV.
Also read: Why Expense Ratio Can Make or Break Your Returns
Formula to calculate TER
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How does TER impact your returns?
TER directly reduces the returns you earn as an investor. For example, if two funds each generate 12% gross returns, a fund with a 1.5% Mutual Fund TER will deliver 10.5% net, while another with 0.8% Low TER funds will give 11.2%. Over 20 years, a ₹5 lakh investment would grow to about ₹28.3 lakh in the first case versus ₹30.6 lakh in the second, with a ₹2.3 lakh gap caused purely by costs. This highlights why tracking TER is crucial when choosing mutual funds.
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SEBI regulations on TER
The Securities and Exchange Board of India (SEBI) has capped the maximum TER fund houses can charge. The larger the fund, the lower the permissible TER impact returns.
For example, an equity mutual fund with an AUM of less than ₹500 crore is allowed to charge a TER of up to 2.25%. But if the same fund’s AUM expands beyond ₹50,000 crore, the maximum permissible TER drops to just 1.05%. This structure ensures that as funds grow larger and achieve economies of scale, the cost savings are passed on to investors rather than retained solely by the fund houses.
Also read: How to Diversify Mutual Fund Portfolio: A Complete Guide to Strategic Asset Allocation
Why do fund houses change TER?
Mutual funds don’t keep TER fixed forever. They revise it regularly, often monthly.
Change in AUM
If AUM increases, the allowed TER reduces (per SEBI TER cap slabs). Conversely, if markets fall and AUM shrinks, TER can increase slightly.
For example, a mutual fund with an AUM of ₹800 crore may be allowed to charge a TER of 2.14%. However, if the fund’s AUM falls to ₹700 crore, the maximum permissible TER rises slightly to 2.18%. This shows how expense ratios are linked to fund size, with smaller funds being allowed to charge higher costs, while larger funds must pass on the benefit of scale to investors through lower TERs.
Market competition
With over 40 asset management companies (AMCs) and hundreds of mutual fund schemes in the market, competition is fierce. To attract investors, new funds often launch with very low TERs, making them look more cost-efficient compared to peers. However, once the fund’s AUM grows to a comfortable level, the fund house may increase the TER, still within SEBI’s prescribed limits. While this strategy helps the AMC improve profitability, it can come as an unpleasant surprise for existing investors, as their long-term returns may get reduced by the sudden hike in expenses.
Rising TERs in Index funds
Traditionally, index funds were known for their ultra-low costs, often charging around 0.1% TER. However, in recent times, even some of the largest funds have increased their expense ratios. For instance, the HDFC NIFTY 50 Index Fund raised its TER from 0.1% to 0.2%, while the UTI NIFTY Index Fund increased from 0.1% to 0.18%.
The reason lies in the underlying costs of running these schemes. Even though index funds don’t involve active management, they still incur custody, compliance, audit, and investor awareness expenses. For years, many AMCs kept TERs artificially low, sometimes even subsidizing them using earnings from actively managed funds. But with more investors shifting towards passive investing, fund houses are now pricing index funds more sustainably. Most experts expect TERs in this category to stabilize between 0.15% and 0.20%, striking a balance between affordability for investors and viability for fund houses.
Also read: Choosing the Right Mutual Fund Type for You
TER in direct vs regular plans
| Type of Plan | How It’s Bought | Includes Distributor Commission? | Typical TER | Impact on Returns |
|---|---|---|---|---|
| Direct Plan | Purchased directly from the AMC (online or offline) | No | 1.0% | Lower costs → higher long-term returns |
| Regular Plan | Purchased through intermediaries (agents, brokers, distributors) | Yes | 1.6% | Higher costs → reduced long-term returns |
The same mutual fund can have different TERs: a direct plan may charge 1% while the regular plan charges 1.6% (including distributor commissions). Over 15–20 years, this 0.6% gap can compound into lakhs, making direct plans more cost-efficient.
Should you always choose the fund with the lowest TER?
A low TER alone doesn’t guarantee a good investment. A fund with minimal expenses but poor performance can still erode wealth, while a slightly higher TER fund that consistently outperforms its peers may deliver better long-term results. That’s why it’s important to compare funds within the same category, for example, large-cap funds with other large-cap funds, rather than across segments. Additionally, always check the Direct Plan vs. Regular Plan TER monthly revision difference, since direct plans typically offer lower costs and can enhance overall returns.
Also read: REITs or Mutual Funds, Which Investment Fits Your Portfolio?
Conclusion
The Total Expense Ratio (TER) may look small, but over time, it can significantly reduce your wealth. Even a 0.5% difference compounded for years can cost lakhs. That’s why TER should always be a key filter when comparing funds. Choosing direct plans, considering low-cost index funds, and keeping an eye on expense ratios help ensure more of your money stays invested. In investing, the rule is simple: “Every cost saved is an extra return earned.”
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