In the previous chapter, we saw one of the major components of cost involved in Mutual Funds – Expense Ratio. We saw that the costs incurred by fund houses in maintaining the portfolio are charged to the investors and a fixed percentage is calculated based on asset value of the fund and termed as expense ratio. While knowing the expense ratio is important before picking funds, you must also consider other fees and loads involved. So, in this chapter, we will brief you with all the fees and loads involved in mutual funds.
What can be a better example than buying a new house to understand the fees and loads better? So let us go 10 year ahead when Ranjit is buying his dream vacation house. When he visits the builder’s office, he discovers that the sea-view villa he selects has a hidden cost involved. The builder has changed his extra as a preferential location charge. This charge is levied for a house with a better view. You might be aware that even in hotels, the rooms with mountain views are charged higher than the rooms with backyard views, right? The same way properties include higher charges for better view.
Apart from that, there are multiple other costs charged by the builder on the property such as maintenance deposit, parking space, interiors, GST, Stamp Duty, Registration Fees, etc. While some of them are charged upfront, others are hidden. A buyer of a new house must be aware of all the charges a builder is levying upon him/her.
Now you must be wondering where you can find the list of all the charges levied upon by the builder at the time of buying a new house, aren’t you? Well, we cannot assure you about that here but we can definitely make you more aware about all the upfront and hidden costs involved in mutual funds by the end of this chapter.
The cost structure in mutual funds is a little complex. So, before starting an investment in mutual funds, it is necessary to understand all the cost components as it directly impacts the net return you earn from investing. Let us begin by first understanding what are load fees.
The specific amount that you pay in addition to the investment value or sales proceeds at the time of buying or selling the units of mutual funds is called ‘load’. The mutual fund company charges you this fee in order to pay it forward to the advisor and the brokerage house for receiving their services. This amount can vary based upon the fund you choose to invest.
Transaction Fees, generally referred to as the Mutual Fund Fees, are the basic trading charges that are levied on investment assets like shares, ETFs and mutual fund units. It is a common cost irrespective of the type of investment option you pick. Transaction fees form a very small but a non-separable part of the total fees and charges levied on the mutual funds.
You must have heard of the terms ‘entry load’ and ‘exit load’ in relation to mutual funds. These are nothing but the front end and back end loads charged by the AMC at the time of entry and exit from the mutual fund investment, respectively. They are collectively known as Sales Loads. Let us understand these loads closely.
However, to foster the mutual funds sector in India, the SEBI has removed the condition of charging entry loads/front end loads. Nowadays, mutual funds do not charge front end loads.
Exit loads are supposed to make the investors stay invested for a longer duration. The rate of exit load varies from fund to fund, and since it is not a mandatory charge, many funds do not charge exit load.
Entry load and exit load are collectively referred to as sales loads. Let us understand the working of these charges with the help of an example.
Suppose you are planning to invest Rs. 1,00,000 in ABC Mid Cap Growth mutual fund. The AMC that manages this fund quotes the following charges on investment:
Expense Ratio = 1.6%
Entry Load = 1%
Exit Load = 3%
This means that when you make investment, you need to pay Rs. 1,01,000 (Rs. 1,00,000 + 1% Entry Load). Let us assume that you earn a return from this mutual fund at the rate of 12.5% per annum.
Now, when you sell your investment, the expense ratio of 1.6% and an exit load of 3% will be charged on the sale proceeds of your mutual fund investment. Your net proceeds will look something like this:
|Investment Value||Rs. 1,00,000|
|Add: Entry Load @ 1%||Rs. 1,000|
|Total Outflow||Rs. 1,01,000|
|Gross Proceeds on Sale||Rs. 1,12,500|
|Less: Expense Ratio @ 1.6%||Rs. (1,800)|
|Less: Exit Load @ 3%||Rs. (3,375)|
|Total Inflow||Rs. 1,07,325|
The above table explains how sales load works and how the implication of loads is reflected on net return you earn from the mutual funds.
Note: It is a hypothetical example for better understanding. Entry loads are not charged by the fund houses after SEBI’s disapproval.
Ranjit’s uncle recently bought a house property in Pune and ended up paying a huge cost towards the transfer fee charged by the society. This was a hidden cost he was unaware of. We do not want you to end up paying more towards the mutual fund investments and to make you aware of all the costs.
So here’s a list of costs, apart from the above mentioned fee loads, you must know.