As we saw in our previous posts, we should have some percentage of our savings in Equity investments to achieve our long term goals. Easy way to invest in Equity is to invest via Mutual Funds since we may not be the expert in choosing the right stocks always. Am not saying Mutual funds always chooses the right stocks. Even they also does mistakes but the probability is relatively lower compared to an individual investor.

So if the road is shine, why to look around ? We have to realize there are some cost associated to mutual fund investments. Since we are getting a service, we have to pay for it. Let’s see how much are we paying on our investments in these funds. Any fund that you are investing will highlight the expense ratio of the fund. Expense ratio is nothing but the cost incurred by the fund house to manage the fund which they will be collecting from the investors like us. Some major component of these costs are salary to the fund manager, marketing, etc.

Suppose I run a fund where the investors have invested 1 Cr. This is called AUM ( Assets under management ). To manage the investor’s money as a fund manager, I am charging 1 lakh per year. So the expense to manage the fund here is 1% of AUM. This is what you see in your fund’s disclosure.

In the above example, its 1.03% of 38,734 Cr which is ~400 Cr. ICICI is charging 400Cr to manage this fund. I hope many people will now understand why we are seeing new players in the mutual fund business. Now we know what expense ratio is. Let see how does it affect our investments ?

Suppose I invest 1 lakh in this fund, then every day they deduct (1.03 percentage of my investments / 365 days). So the value of my investment next day will be 1,00,000 – 2.82 (1.03% of 1 lakh is 1030. Dividing it by 365 gives 2.82). Here 2.82 is the cost that am paying to AUM every day. This is be deducted irrespective of whether you make profit or not. 2.82 might seem like a small amount but 1% of your investment per year will be a reasonable expense as you grow your investments.

Btw, this is just to make aware of what and how much are we paying to mutual funds and not to run away from it. On a long run, these charges are taken care by the returns that we make. So when you choose a fund, this expense ratio is a key parameter to check. So all the fund’s expense ratio is same ? No. It depends on the fund’s nature and the fund manager’s experience as well. There are funds like Index funds (Ex. Nifty 50) where the fund manager need not do much. They just need to make sure whether investments are properly invested in the Nifty 50 companies in the right weightage. These types of funds are called as Passive funds and usually their expense ratio is way lesser than the active funds where the fund manager spends a lot of time to pick the stocks.

The only thing which I don’t like about the expense ratio is charging it with respect to % of our investments. I still remember the days when the brokerage companies charge the traders based on the amount of trade. When I started in Angel broking in 2014, I think the broker charges are 0.025% of the trade amount. All the brokerage company does is place my trade on the NSE/BSE and get my share. This is when players like Zerodha came in and pitched fixed charge irrespective of the trade amount. If I traded for 10,000 or 10 lakh, the brokerage charge is same. This feels like the game is played right !

Do we have any such mutual funds which charges fixed amount ? Yes, we have Smallcases to our rescue.

In Smallcases, a fund manager can create a small case and define the thought process on how do they select stocks, when do they rebalance the portfolio, etc. These small cases can be integrated to our brokerage accounts. So when a fund manager feels that they need to add a new stock and remove one from existing, they send a rebalance request and when we approve, the changes happens on our brokerage account. This is pretty much similar to Mutual funds with fixed charges and more transparent.

This will be helpful for people with good capital to invest. Suppose the subscription fee is 7,000 per year, and if we invest 10,000 per month as SIP in the small case. End of the year, we are loosing 5.8% of our investment which is huge. If we invest 50,000 per month, then the charge will be 1.16% which is actually high compared to most of the expense ratio of Mutual funds. But as year passes by, this % will slowly come down whereas mutual fund expenses doesn’t change much year on year.

One good thing is, there are some small cases which are available for free and they have even outperformed Index and some mutual funds in the last 7 years. Some good ones are

If we want to try small cases, we can get started with something like this and see how it performs over next few years. I would prefer to give at least 2 years and review how they performed against overall Index, Mutual funds, etc. If we are confident, then we can slowly start increasing the allocation to these smallcases and review again. One fact that we should note is, these smallcases are concentrated. ie) They mostly have 10 to 15 stocks in their portfolio. So there is always high risk compared to the mutual funds whether the stock diversification could even go to 100s of stocks.

I hope this post would have given some idea about the mutual fund expenses, small case expenses and how the free small cases can help reducing the expenses. Please do subscribe and share to your friends and family.