Definition
Expense Ratio Drag
Expense ratio drag is the cumulative effect of a fund's annual costs quietly reducing your returns and compounding into a large shortfall over time.
A fund's expense ratio is deducted every year from its assets, so even a seemingly small percentage difference between a high-cost regular plan and a low-cost direct plan or index fund compounds into a significant gap over decades. The cost is invisible in the NAV but very real in foregone wealth.
Because costs are one of the few things investors can control, minimising them — favouring direct plans and low-cost index funds where appropriate — is among the most reliable ways to improve long-term outcomes. Over a multi-decade horizon, expense ratio drag can rival the impact of many an investment decision.
Related terms
- Real vs Nominal ReturnNominal return is the headline percentage gain on an investment; real return is that figure adjusted for inflation, reflecting true change in purchasing power.
- Time Value of MoneyThe time value of money is the principle that a rupee today is worth more than a rupee in the future, because today's rupee can be invested to earn returns.
- Recency Bias in Fund SelectionRecency bias in fund selection is the error of choosing mutual funds mainly on their latest short-term returns, expecting that recent outperformance will persist.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.