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How Expense Ratios Impact Long-Term Portfolio Performance
Jun 15
3 min read
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In investing, it’s not just what you earn—it’s what you keep.
When evaluating mutual funds, most investors focus on past returns. But a key number often gets ignored: the expense ratio.
It might seem small—just 1% or 2%—but over time, this tiny percentage can significantly reduce your overall wealth.
Understanding how expense ratios work and how to use them in fund selection is one of the most underestimated skills in investing.
Let’s decode expense ratios and show you how to make more cost-effective choices—without compromising performance.
1. What Is an Expense Ratio?
An expense ratio is the annual fee charged
by a mutual fund to manage your money. It’s expressed as a percentage of the fund’s total assets.
It covers costs like:
Fund management
Administrative expenses
Marketing and distribution
Custodian and audit fees
So if a fund has an expense ratio of 1.5% and you invest ₹1 lakh:
₹1,500 is deducted yearly from your returns (proportionally every day)
You don’t pay this fee separately—it’s adjusted daily in the NAV of the fund.
2. Why It Matters: Small % = Big ₹₹₹ Over Time
Let’s compare two funds with the same gross return of 12% per annum:
Fund | Expense Ratio | Net Return | Corpus After 20 Years (₹10K/month SIP) |
Fund A | 1.5% | 10.5% | ₹76.5 lakhs |
Fund B | 0.5% | 11.5% | ₹83.2 lakhs |
📉 Difference = ₹6.7 lakhs, just because of a 1% difference in expense ratio.
A high expense ratio slowly eats into your compounding—without you noticing.
3. Active vs. Passive: Where Expense Ratios Really Differ
Type of Fund | Typical Expense Ratio Range |
Active Equity Funds | 1.0–2.25% |
Index Funds (Passive) | 0.1–0.3% |
Direct Mutual Funds | 0.5–1% lower than regular |
Active funds cost more because they employ analysts, research teams, and managers to try and beat the market.
Index funds are cheaper because they track the market passively—no active management needed.
For long-term investors, choosing a lower-cost fund in the same category can lead to better net returns—even with modest performance.
4. Direct vs. Regular Plans: The Hidden Cost of Distribution
Mutual funds are available in two versions:
Regular Plan: Includes distributor commission → higher expense ratio
Direct Plan: No commission → lower expense ratio
Example: | Regular Plan | Direct Plan |
Fund A (Large Cap) | 1.8% | 1.0% |
Over 15–20 years, this 0.8% gap can result in ₹5–10 lakhs of difference for the same fund.
If you’re confident managing your investments, consider going direct.
5. Don’t Choose a Fund Just for Low Expense Ratio
Yes, lower is better all else being equal. But don’t blindly choose the fund with the lowest fee.
What matters more:
Consistency of returns
Risk-adjusted performance (Sharpe ratio)
Fund house reputation
Portfolio quality
The ideal fund is one that balances performance and cost—not just one with the cheapest label.
6. When to Prioritize Low Expense Funds
For long-term goals (retirement, education)—to maximize compounding
For large investments where even 0.5% makes a big rupee impact
For core portfolio holdings like index funds
When building a DIY portfolio with direct plans
TL;DR — Too Long; Didn’t Read
Expense ratios are the annual cost of running a mutual fund, deducted daily from your NAV
A small % difference can lead to lakhs of rupees lost or gained over time
Index funds and direct plans are more cost-efficient
Don’t ignore performance—but factor in cost before committing
Over 15–20 years, the lower the cost, the higher your net wealth
