Choosing a mutual fund - by Hyderabad_guy
What is the most important yardstick for choosing a mutual fund? Returns? Indeed, how much the investment will earn should logically be the key factor guiding your decision. But there is no way anyone can predict how a mutual fund will perform in future. The past performance of a fund is like a rear view mirror in a car—it gives you an idea of the broad direction but can’t tell you exactly where you are headed.
While an investor cannot predict how much a fund will earn, he can certainly know how much he is paying the fund house, in fees and other charges. Besides the entry and exit loads levied at the time of buying and selling, fund houses also charge investors an annual fee for managing their money. Also known as the expense ratio, this annual charge varies from fund to fund. A diversified equity fund may have an expense ratio of 2.5% a year while a passively managed index fund from the same fund house may be content with just 1%. An exchange-traded fund may charge just 0.5% a year.
Fund houses do not have a free hand in charging the expense ratio. Sebi guidelines allow funds to charge 2.5% for average daily net assets of up to Rs 100 crore, 2.25% for the next Rs 300 crore and 2% for the next Rs 300 crore. If the AUM is bigger, the maximum charge on the balance is 1.75%.
A 2.5% annual charge may seem insignificant in the short term, but if you are a long-term investor, it can make a big difference to your overall return . If you invested Rs 50,000 in fund B that charged 0.75% and your friend invested in fund C which charged 2.25%, at the end of 15 years, you would have about Rs 35,000 more than him simply because your fund’s annual fees was lower. Of course, this calculation assumes that both funds earned the same nominal return.