The annual fee charged by a mutual fund or ETF, expressed as a percentage of assets under management, covering fund management, administration, and distribution costs.
The expense ratio (also called Total Expense Ratio or TER) is the annual fee charged by a mutual fund or ETF to cover operating costs - fund manager compensation, administrative expenses, custodian fees, audit fees, and (for regular plans) distributor commissions. It is expressed as a percentage of the fund's AUM and is deducted daily from the fund's NAV.
In India, SEBI caps expense ratios based on fund category and AUM size. For equity funds, the maximum is 2.25% for AUM up to Rs 500 crore, reducing to 1.05% for AUM above Rs 50,000 crore. For debt funds, the caps are 25 basis points lower. These caps apply to regular plans - direct plans (which exclude distributor commissions) are typically 0.50-1.00% cheaper.
The difference between regular and direct plan expense ratios is significant over time. A regular equity fund charging 1.80% TER vs a direct plan at 0.80% has a 1.00% annual drag. On Rs 10 lakh invested at 12% gross return over 20 years: the regular plan grows to Rs 66 lakh, while the direct plan grows to Rs 82 lakh - a Rs 16 lakh difference from that 1% cost gap. This cost gap is why direct plans dominate AUM share among self-directed and fee-only-advised investors.
Index funds and ETFs have the lowest expense ratios in India - typically 0.05-0.20% for large Nifty 50 index funds (direct plan). Active equity funds charge 0.50-1.50% (direct) or 1.50-2.25% (regular). Debt funds range from 0.10-0.80%. International fund-of-funds can charge up to 2.25% plus the underlying fund's expenses (double-layered fees).
Expense ratio is read alongside performance during mutual fund evaluation. A fund delivering 15% return with 0.50% TER (net return: 14.5%) is mathematically ahead of one delivering 15% with 1.50% TER (net return: 13.5%). Over 25 years, that 1% annual difference compounds into a 25-30% difference in final corpus. For passive investing, expense ratio is the dominant differentiator because all Nifty 50 index funds track the same benchmark - the lowest TER paired with the lowest tracking error captures the benchmark return most efficiently.
Formula
Expense Ratio = Total Annual Fund Expenses / Average AUM x 100India Context
SEBI caps TER by AUM slab. Direct plans are 0.5-1.0% cheaper than regular plans. Nifty 50 index funds: 0.05-0.20% TER. Active equity funds: 0.50-2.25%. Choose direct plans for lower costs.