Expense Ratio in Mutual Funds: Meaning, Formula, Calculation, and Impact

In summary

The expense ratio measures the cost of running a mutual fund scheme and is expressed as a percentage of its assets. Investors do not usually pay it as a separate bill. Permitted expenses are charged to the scheme and reflected in its NAV.

The ratio matters because costs reduce the return available to investors. However, a lower ratio does not automatically make one fund better than another.

• Calculation: Expense ratio broadly compares expenses with average assets under management.
• Deduction: Expenses are reflected in the fund's NAV on an ongoing basis.
• Comparison: Compare similar funds within the same category and investment style.
• Active funds: They generally have higher costs because of research and active portfolio management.
• Passive funds: Index funds and ETFs generally have lower operating costs.
• Direct plans: They generally have lower expenses because distributor commissions are not included.

SEBI's 2026 framework distinguishes Base Expense Ratio (BER) from Total Expense Ratio (TER), with statutory and certain other permitted costs treated separately from BER.

An expense ratio is the percentage of a mutual fund's assets used to meet permitted expenses of operating and managing the scheme. These can include investment management, administration, distribution-related costs, regulatory expenses, and other permitted charges.

For example, a 1% expense ratio broadly means that expenses equivalent to 1% of the relevant asset base are incurred over a year. It does not mean that Rs. 1 is separately deducted from every Rs. 100 in your bank account.

The cost is reflected through the scheme's NAV. You can understand the broader concept through mutual funds.

The expense ratio reduces the assets available to generate returns for investors. Its effect can therefore become more noticeable over a long investment period because the amount that remains invested also participates in compounding.

Consider two otherwise similar funds. If one has a 0.50% expense ratio and another has 1.00%, the second fund has a higher annual cost. This difference alone does not establish which fund will deliver the better net return because investment performance, portfolio construction, and risk also matter.

Understanding the compounding effect helps explain why recurring costs can matter over longer periods.

The basic formula is:

Expense Ratio = Total Expenses ÷ Average AUM × 100

For example, assume a mutual fund has average AUM of Rs. 800 crore and eligible expenses of Rs. 16 crore.

Expense Ratio = Rs. 16 crore ÷ Rs. 800 crore × 100 = 2%

This illustrates the calculation. Actual scheme TER is determined according to the applicable regulatory framework and the expenses charged by the scheme.

The fund manager and Asset Management Company are responsible for functions that can contribute to the overall operating structure of a fund, but the expense ratio covers more than the fund manager's remuneration alone.

Not necessarily. A lower cost is useful, but it should be considered alongside the fund's investment objective, portfolio, risk, benchmark, investment strategy, and performance.

For example, paying a somewhat higher expense ratio for an actively managed fund may be reasonable if its investment approach and results justify the additional cost. The comparison should therefore be between funds with similar mandates rather than across unrelated categories.

Your risk tolerance and financial goal should remain part of the decision.

The exact permitted components depend on the applicable SEBI framework. They can include:

• Investment management: Costs associated with managing the scheme's portfolio.
• Administration: Accounting, registrar, custody, audit, and related operating expenses.
• Distribution: Permitted distribution and service-related expenses, particularly for regular plans.
• Marketing: Permitted investor communication and distribution-related expenditure.
• Brokerage and transaction costs: Certain permitted costs are treated separately under the current framework.
• Statutory levies: Applicable statutory and regulatory charges can be outside the BER but form part of TER under the 2026 framework.

An ETF versus mutual fund comparison can help explain why passive products often have different cost structures.

Under the SEBI Mutual Funds Regulations, 2026, open-ended schemes other than specified categories have maximum BER limits based on daily AUM. The limits differ for equity-oriented and other-than-equity-oriented schemes.

Last updated: October 2026

For specified passive schemes, the maximum BER for index funds and ETFs is 0.90%. Separate limits apply to different fund-of-funds structures.

The TER is broader than BER because it can include BER, permitted brokerage, transaction costs, and statutory levies as prescribed under the 2026 framework.

A direct mutual fund plan is purchased without a distributor, while a regular plan involves distribution through an intermediary.

Regular plans generally have higher expenses because permitted distributor-related costs are included in their cost structure. Direct plans generally have lower expense ratios because distributor commissions are not included.

This does not mean that direct plans are automatically suitable for every investor. The choice should also consider how you select, monitor, and manage investments.

Several factors can affect the cost of running a scheme.

• Fund type: Active funds generally require more research and portfolio-management activity than passive funds.
• Fund size: Larger AUM can allow fixed costs to be spread across more assets.
• Management approach: Frequent research and trading can increase operating costs.
• Distribution structure: Regular plans can include distributor-related expenses.
• Portfolio complexity: Certain strategies may require additional research, infrastructure, or operational resources.

Portfolio turnover ratio can provide additional context when assessing how actively a portfolio is traded.

Compare funds with similar objectives rather than selecting the lowest percentage available.

For example, an index fund should generally be compared with other comparable index funds, while an actively managed equity fund should be assessed against relevant active peers. Alongside costs, examine the fund's portfolio, benchmark, performance, risk, and investment approach.

You can also consider current ratio, cash ratio, treynor ratio, and operating ratio where relevant to broader financial analysis.

The expense ratio applies to the mutual fund's assets, including units accumulated through an SIP. It is not a separate fee charged on every SIP instalment.

As the investment value changes, the rupee impact of the scheme's expenses changes as well. Over a long period, the cost can affect the difference between gross investment performance and the return ultimately reflected in the investor's holdings.

You can model different investment assumptions using the mutual fund calculator, lumpsum calculator, SIP investment calculator, and step-up SIP calculator from Bajaj Finance. 

Management fees are one component of the broader cost of running a fund. The expense ratio or TER can include several permitted expenses beyond investment management.

Last updated: October 2026

The distinction matters because looking only at the fund manager's fee does not provide the complete picture of what the scheme costs.

The expense ratio itself does not determine Income Tax treatment. Tax depends primarily on the type of mutual fund, its equity exposure, acquisition date, holding period, and applicable tax provisions.

For qualifying equity-oriented mutual funds, STCG is generally taxed at 20%, while qualifying LTCG is taxed at 12.5% on gains exceeding Rs. 1.25 lakh in a financial year, subject to applicable conditions. For specified debt mutual funds acquired on or after 1 April 2023, gains are generally taxed at the applicable Income Tax slab rate.

The expense ratio and taxation should therefore be considered separately when estimating post-tax returns.

Expense ratio is one factor in fund selection, not a standalone ranking metric.

• Category: Compare costs with similar schemes.
• Investment style: Understand whether the fund is active or passive.
• Performance: Examine returns over appropriate periods and against the benchmark.
• Portfolio: Review holdings, concentration, and sector exposure.
• Risk: Consider the SEBI Riskometer and your own risk capacity.
• Plan type: Compare direct and regular plans on their applicable costs and services.
• Long-term effect: Consider how recurring costs may affect compounding.
• Overall value: Decide whether the cost is reasonable for the strategy and outcomes delivered.

The expense ratio is an important measure of the ongoing cost of investing in a mutual fund. It can affect net returns over time, but a lower ratio does not automatically make a fund superior.

Compare costs among similar funds while also assessing investment strategy, portfolio, risk, performance, plan type, and suitability. Under the 2026 SEBI framework, distinguish BER from the broader TER when evaluating scheme costs.

Last reviewed: October 2026

Mutual funds are subject to market risk. Please read the scheme-related documents carefully before investing.