Need Expert Advice?Our Gurus Can Help

Ramalingam Kalirajan |7847 Answers |Ask -Follow

Mutual Funds, Financial Planning Expert - Answered on May 04, 2024

Ramalingam Kalirajan has over 23 years of experience in mutual funds and financial planning.
He has an MBA in finance from the University of Madras and is a certified financial planner.
He is the director and chief financial planner at Holistic Investment, a Chennai-based firm that offers financial planning and wealth management advice.... more

Question by Raghu on Apr 13, 2024Hindi

Hi, I have a question about the expense ratio in mutual funds. I have invested in direct mutual funds both Parag Parikh ELSS (expense ratio - 0.69%) & Parag Parikh Flexi Cap (expense ratio - 0.57%). I have invested 25000/- each in both funds, one of my friend suggested to invest in any one of the funds as this will affect the returns for in longer period, and I am planning to invest for another 10 years in both funds. Question: Is it okay to be invested in both funds, I'm aware that the funds overlap, but I want to check on the expense ratio difference in the cost for 10 years. Can you please help me understand the calculation so that I can make a better decision? Expense ratio is calculated for the amount that I invest, either I invest 50k in one of the funds or split 25k each in both funds having a difference of 0.12% in expense ratio. How much of this will affect the end corpus and how is that I can calculate for the other mutual funds that I'm currently investing in? please suggest me on this.

Ans: You're absolutely right, even a small difference in expense ratio can affect returns over time. Here's how to analyze your situation and the impact of expense ratios:

Impact of Expense Ratio on Returns:

The expense ratio is a percentage of your investment deducted annually to cover fund management fees. A lower expense ratio means more money stays invested and has the potential to grow through compounding.

Calculating the Cost Difference:

Annual Cost Difference: Multiply the expense ratio difference (0.12%) by your total investment amount (25000 + 25000 = ?50,000). So, 0.12% * ?50,000 = ?60 per year.

Cost Difference over 10 Years: Multiply the annual cost difference (?60) by the number of years (10). This gives you ?600 as the total expense ratio cost difference over 10 years.

Is ?600 Significant?

While ?600 might seem small, it's crucial to consider the power of compounding over 10 years. Let's say you earn an average annual return of 12%. Here's a simplified comparison:

Investing in Both Funds: Your total return after 10 years would be impacted by the expense ratio difference of ?600. There's a chance you might have slightly more if you invested in the single fund with the lower expense ratio.

Investing in One Fund: This scenario eliminates the expense ratio difference, potentially leading to a slightly higher return due to slightly more money compounding over time.

Making an Informed Decision:

Diversification Benefit: Both Parag Parikh ELSS and Flexi Cap represent different fund categories (ELSS & Flexi Cap). Holding both provides diversification, which can help mitigate risk.

Expense Ratio vs. Diversification: The diversification benefit of holding both funds might outweigh the small cost difference in expense ratios.

Consider Overall Portfolio: Analyze your entire investment portfolio. If you have other diversified funds, then holding both Parag Parikh funds might be redundant.

Calculating for Other Funds:

Use the same method mentioned above. Find the expense ratio difference between the funds you're comparing and multiply it by your investment amount to get the annual cost difference. Then multiply by the number of years you plan to invest.
Recommendation:

It's difficult to definitively say whether consolidating is best. Here are some options:

Maintain Both Funds: The diversification benefit might be valuable. Track the performance of both and re-evaluate if one consistently underperforms.

Consolidate: If you have other diversified funds, consider consolidating to the fund with the lower expense ratio.

Invest More in Lower Expense Ratio Fund: Increase your investment proportionally in the Parag Parikh Flexi Cap (lower expense ratio) to potentially gain a slight edge over time.

Consulting a Financial Advisor:

A financial advisor can analyze your entire portfolio, risk tolerance, and goals to provide a personalized recommendation.

DISCLAIMER: The content of this post by the expert is the personal view of the rediffGURU. Users are advised to pursue the information provided by the rediffGURU only as a source of information to be as a point of reference and to rely on their own judgement when making a decision.