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Here’s why you should avoid mutual funds with high Expense Ratio

Mutual funds are a great way to get into the capital market as a retail investor, a great way to have a diversified investment portfolio and a great way to have your portfolio managed on your behalf by professional asset managers.

But as they say, there is no free lunch. Nothing good comes easy and whatever you are eating thinking it is free, think once, think twice, someone somewhere is paying for it somehow.

In one of my recent articles, I noted that the cost of a mutual fund is one of the major factors investors in the United States consider when choosing a fund. Apparently, that should be said of Nigerian investors as well. However, more often than not, people invest in mutual funds either without looking at the cost before, while or after investing.

One thing about the cost of investing in mutual funds is that it is not static as some fees are flat while others are asset-based. It is therefore important that investors review the cost of the funds they are investing in from time to time.
Expense Ratio
Expense ratio is the common statistics used to capture how much a mutual fund cost. In most cases, information on the expense ratio is provided as part of the monthly fact sheet of a fund, where available. If not provided, investors should be at liberty to ask for such information from their fund managers or asset management company.

Expense ratio is the percentage of a fund’s asset value that goes into running the fund. Remember that the net asset value (NAV) of a fund is the total asset of the fund less its total liabilities and less the expenses incurred in the operation of the fund. The expenses include management/incentive fees and administrative fees (admin, audit, legal, professional, etc.). So, the expense ratio is the total cost expressed as a percentage of the net asset value of the fund.

Expense Ratio in Nigeria
Some fund fact sheets of Nigerian mutual funds show expense ratios but a great majority do not. However, combing through available data and information, I have presented below the expense ratio for Exchange Traded Funds in Nigeria for the month of February, 2021. Among the ETFs, Vetiva Consumer Goods ETF has the highest expense ratio of 0.31%, however, when compared with January, 2021, the expense ratio for Vetiva Consumer Goods ETF decreased by 0.01%, which is good for investors. New Gold ETF is the ETF with the lowest expense ratio of 0.01% as of the end of February 2021. For some reason, the expense ratio for Stanbic ETF 30, SIAML ETF 40 and Lotus Halal 15 ETF increased by 0.1, 0.07 and .08 percent respectively while that of Vetiva Banking ETF decreased by 0.06 percent.

Source: SEC/Quantitative Financial Analytics Ltd

We will be monitoring the expense ratios and will bring the information your way so that you can make a credible investment decision. Look out for my next article also as I will be presenting a chart of the expense ratio of the rest of the mutual funds in Nigeria.

What this means for investors
When you invest in a mutual fund, the asset management company takes its fees or expenses out of your proportionate share of the fund’s asset value which will impact the eventual value of your fund investment.

For example, if you invest N100,000 in a mutual fund that returns 4% average yearly return for 10 years, the impact of the expense ratio can be as follows.

You can see from above that, even though you invested the same amount in three different funds with the same annual average return, at the end of 10 years, the value of your investment is lowest for the fund with the highest expense ratio.

The implication of the above to an investor is that the mutual fund expense ratio reduces the return you derive from a fund. Therefore, as much is possible, avoid funds with high expense ratios unless the return more than compensates for such a high expense ratio.

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