With longer life expectancies and rising costs, building a retirement corpus of Rs. 5 crores has become a common goal. However, high fund expense ratios can significantly impact long-term returns and derail the Rs. 5 crore target. Controlling mutual fund costs is crucial to achieving this sizable retirement goal.
Understanding expense ratios
Expense ratio refers to the annual fee charged by mutual funds to manage investments. It is expressed as a percentage of assets under management. Expense ratios typically range from 0.5% to 2.5% in India.
The expense ratio consists of:
- Fund management fees
- Other operational expenses
- Commissions paid to distributors
A higher expense ratio implies higher fees paid by investors to the fund house, leaving a smaller portion of returns.
Impact on Rs. 5 crore goal
Consider a monthly SIP of Rs. 20,000 in diversified equity funds for 25 years targetting Rs. 5 crores. Assuming a 12% annual return on mutual fund, a 1% expense ratio would reduce the final corpus by around Rs. 87 lakhs compared to zero costs.
With a 2% expense ratio, the corpus would reduce further by Rs. 1.7 crores. The disproportionate erosion highlights why expense ratios matter in long-term wealth creation. Lowering costs by even 1% can make a dent of crores in the ultimate corpus.
How to select mutual funds?
Index funds: Opt for index funds like Nifty 50 and Sensex that simply track the index at costs of 0.1% or lower.
Direct plans: Avoid regular plans with commissions, and buy direct plans. Expense ratios are lower by ~1%.
Passive funds: Consider passive funds that track a particular index at lower costs.
Fund size: Larger funds benefit from economies of scale and tend to have lower expense ratios.
Fund house: Some fund houses are known to offer funds at lower costs.
Actively managed funds try to beat benchmarks and tend to charge higher fees. Index funds and ETFs offer market returns at minimal costs ideal for long-term investing.
Review portfolio periodically
Review your mutual fund portfolio at least annually to identify funds whose costs have increased over time. Consider switching to alternate low-cost funds in the same category.
For example, a multi-cap fund with 1% expense ratio that increases to 2.5% should be replaced with a lower cost alternative. Periodic rebalancing also ensures your asset allocation remains on track to achieve the Rs. 5 crore figure.
Avoid chasing past returns
Past returns should not be the prime factor while selecting funds. Higher costs can eat into future returns. For example, a multi-cap fund returning 15% with 2.5% expense ratio is less desirable than an index multi-cap fund returning 13% with just 0.1% expense ratio.
The lower cost fund is likely to deliver higher future returns. Analyse both costs and returns while reviewing and selecting mutual funds.
Expense ratios can substantially erode corpus over long investment horizons. To achieve the Rs. 5 crore figure, investors must proactively control mutual fund costs in their portfolio. Investing in low cost index funds and ETFs can meaningfully improve chances of reaching the sizable retirement target. Keeping expenses low allows the power of compounding to work its magic.