Page 42 - Banking Finance April 2025

ARTICLE

Mutual Funds :

Understanding

Expense Ratios and

Their Impact on

Returns

In the world of long-term investing, it is often said that "time in the market" beats "timing the
market." While investors focus heavily on selecting the right mutual fund, index fund, or exchange-
traded fund (ETF), they often overlook a critical factor that silently chips away at their returns-
expense ratios.

Introduction include management fees, administrative expenses, legal
fees, marketing costs, and other operational expenses.
In the world of long-term investing, it is often said that "time
For example, if a mutual fund has an expense ratio of 1.5%,
in the market" beats "timing the market." While investors
it means the fund deducts 1.5% of your investment annually
focus heavily on selecting the right mutual fund, index fund,
to cover its operating costs, regardless of the fund's
or exchange-traded fund (ETF), they often overlook a critical
performance.
factor that silently chips away at their returns-expense
ratios. Even seemingly small fees can have a substantial
Types of Expense Ratios
impact on wealth accumulation over time. Understanding
expense ratios is vital for investors who want to make 1. Gross Expense Ratio: Reflects the total annual
informed decisions and maximize their investment gains in operating expenses of the fund before any fee waivers
the long run. or reimbursements.
2. Net Expense Ratio: Shows the actual expenses paid by
This article demystifies the concept of expense ratios, investors after fee reductions or subsidies by the fund
explains how they are calculated, and illustrates their manager. This is the figure investors should focus on.
influence on investment returns through practical examples
and long-term projections. Impact on Long-Term Returns
The influence of expense ratios on long-term investing is
What is an Expense Ratio? significant due to the compounding effect. A higher expense

An expense ratio represents the annual cost of managing ratio reduces the amount of capital that remains invested,
an investment fund, expressed as a percentage of the fund's which in turn diminishes the growth potential of the
average assets under management (AUM). These costs investment.

38 | 2025 | APRIL | BANKING FINANCE