Why is the expense ratio important for investors?

The expense ratio is a critical factor for investors to consider because it affects how much money you will end up with after all fees are deducted. Even a seemingly small difference in expense ratios can significantly impact long-term returns. For instance, investing Rs. 20,000 in a fund with a 2% expense ratio means you’re paying Rs. 400 annually for the fund manager’s services.

The reason why the expense ratio is important is simple: the higher the expense ratio, the less of your investment is left to grow. Therefore, it’s vital to choose a fund with a reasonable expense ratio that won’t eat into your potential profits. A high expense ratio reduces your net returns over time, especially in funds with lower yields.

The expense ratio helps to distinguish between actively and passively managed funds. Active management typically involves more research and strategy, justifying a higher fee.

Regular funds, distributed through intermediaries, often have a higher expense ratio compared to direct funds because distributors charge commissions. These commissions can eat into your returns over time, which is why many investors prefer direct funds to minimise costs.

For example, if you're comparing two funds with similar investment objectives and holdings, choosing the one with a lower expense ratio can mean better long-term results, all else being equal.