Keeping expenses low can become as important in the overall growth of a healthy portfolio, as choosing the right investment avenues. Any investor looks at two aspects - one is whether he can generate excess returns in his investments and two, whether these returns can be generated at a lower cost. Statistics dont lie - over a long period of time, say thirty years, a one per cent expense ratio on your investment which earns you around ten percent returns compounded can result in returns getting reduced by as much as twenty five percent, compared to an investment which does not have an expenses.
A zero expense investment is a mirage, or a rarity. Hence investors should try and do the next best thing, which is try and keep expenses low. Portfolio, this week, spoke to experts from Ambit Capital and Kunal Bajaj of Clearfunds about how is it that an investor can keep these expenses low, particularly while investing in Mutual Funds. Mutual funds or stocks or any good investment made for a long period of time benefits because of the power of compounding. While the Power of Compounding is your best friend, compounding costs are tyrannical, and act like cancer that eat into your portfolio. Hence, felt the experts, buying mutual funds direct, and trying to get the expense ratio as low as possible, is one terrific idea to reduce the expenses.
Kunal Bajaj said that over 30 years, if you pay just 1% fee for your investment in mutual funds, you are left with 25% less. And this money goes to the distributor or the advisor or the bank relationship manager. This money is your money, and someone else kids are going abroad to study on the back of your savings.
Ambit Capital felt that with an assumption of large cap mutual funds giving similar returns as Nifty ETFs from here on, a lower expense ratio will end up working in the investors favour. Saurabh Mukherjea went on to say that out of the 100 large cap mutual funds, 3-4 funds have proven ability to generate consistent alpha. The rest, he said, meant buying a glorified tracker fund, whether one likes it or no
The authors' math brings out a comparison between two funds. The illustration assumes an investment of Rs 1 lakh over forty years, earning a return of 15%. The first fund has an expense of 2.5 per cent per annum while the second has an expense ratio of 0.1 per cent per annum.
The First fund's corpus exceeds that of the first fund by
24 percent after ten years
53 percent after twenty years
80 per cent after thirty years
133 per cent after forty years
Can you believe the difference??!!!!!
A twenty year old who invests Rs 1 lakh in a fund, with an assumption that the fund can earn 15 percent returns on average through the cycle, will end up getting 1.1 crores from the first fund against earning 2.58 crore from the second. The funds may not return 15 percent, and may end up returning lower or higher, but the impact of the expense will still be meaningful.
