Investing in mutual funds for the first time? One mistake can reduce your profits! Understand the whole process..

In today's world, mutual funds have become the most popular investment option. Whether it's through SIPs (Systematic Investment Plans) or lump-sum investments, people are increasingly turning to mutual funds in the hope of better returns. Experts also believe that mutual funds can deliver an average return of up to 12% in the long term. However, most first-time investors ignore a crucial factor. As a result, they end up with lower-than-expected profits. That factor is the Expense Ratio. If you don't understand it, it will directly impact your returns. Here's what you need to know about it.

Why isn't the return what it seems?
Investors often think that if a fund has given a return of 12% or 15%, they will also receive the same benefit. But the reality is slightly different. In fact, some expenses are deducted before the fund's return is calculated. These expenses together make up the Expense Ratio. This is why your net return is slightly lower.

Mutual funds are managed by Asset Management Companies (AMCs). AMCs incur various expenses such as:

Fund management
Marketing and distribution
Legal and audit expenses
Custodian and transaction costs
All these expenses are borne by the investors. The percentage of these expenses deducted from your investment is called the Expense Ratio. In simple terms, the cost of running the mutual fund is the Expense Ratio.

What difference does a higher or lower Expense Ratio make?
Higher Expense Ratio = Lower Returns
Lower Expense Ratio = Higher Profits

If two funds are giving similar returns, the fund with a lower Expense Ratio will be more beneficial for you. This difference becomes quite significant in long-term investments.

The Expense Ratio is not deducted all at once
It's also important to understand that the Expense Ratio is not deducted in a single go. Fund houses calculate their daily expenses. The annual Expense Ratio is divided by the number of trading days in the year. This is then adjusted daily with the Net Asset Value (NAV). This means you don't have to pay anything extra separately, but your returns are gradually affected by it.

Why is the Expense Ratio different for every mutual fund?
Each AMC (Asset Management Company) sets its Expense Ratio based on its costs and strategy. Active funds usually have a higher Expense Ratio. It is lower in passive or index funds. This is why you should always check the fund details before investing.

Also, understand the types of mutual funds:
Mutual funds are divided into several categories:

Equity Funds: These funds invest in the stock market. The risk is higher, but the potential for returns is also higher.

Debt Funds: These invest in safe instruments like treasury bills, corporate bonds, and government securities. The risk is lower.

Hybrid Funds: These have a mix of both equity and debt. They aim to provide balanced returns.

Keep these things in mind before investing:
Don't choose a fund based solely on returns.
Always check the Expense Ratio.
Be patient in the long term.
Choose a fund according to your risk profile.

Disclaimer: This content has been sourced and edited from Zee Business. While we have made modifications for clarity and presentation, the original content belongs to its respective authors and website. We do not claim ownership of the content.