Mutual funds are becoming highly popular in India owing to their attractive returns and low cost structure. The low cost of investment associated with mutual funds can help investors earn significantly high returns and is one of the key reasons for their increasing popularity.
But unless you know what mutual fund charges are applicable to your investments, you may end up losing a significant chunk of your profits.
What are the Mutual Fund Costs?
In the following sections, we will discuss some of the key mutual fund investment costs that you should keep in mind when investing in any scheme.
Entry Load in Mutual Funds
Entry Load refers to mutual fund charges paid by investors when they ‘enter into a mutual fund scheme‘ for the first time. This is designed to cover the distribution expenses borne by the fund house while promoting a mutual fund scheme.
Earlier entry load in India used to be around 2.25% of the value of the investment. But in 2009, the market regulator SEBI (Securities and Exchange Board of India) abolished entry loads for all types of mutual funds in India. Thus, at present, investors in India need not pay any entry load while investing in any mutual fund scheme.
Exit Load in Mutual Funds
Exit Load is one of the key mutual fund charges of a scheme. It is paid by an investor at the time of redeeming the mutual fund units. This charge is put in place in order to discourage investors from exiting the scheme. Exit loads are not mandatory for mutual fund investments. However, if a fund house wants to, it can charge an exit load up to the maximum limit of 7%.
Exit load tends to vary from one scheme to another. Some fund houses charge a flat exit load whereas others charge it on the basis of holding period – lower exit load for the investments that are held for a longer period and higher exit load for the investments that are held for a relatively shorter duration.
As per SEBI guidelines, a fund house is allowed to charge a maximum exit load of 7% of the redemption amount. However, fund houses generally charge an exit load of 1% on redemption value to keep the schemes attractive.
This is by far the most important of mutual fund charges that you need to keep in mind. Expense Ratio is expressed as a percentage figure and refers to the annual fee charged by a fund house for the management of a mutual fund scheme.
Expense ratio is calculated by dividing the total expenses incurred in the management of a scheme by the total AUM (assets under management) of the scheme. The total expenses of a fund include costs borne by a fund house for administration, marketing, distribution and promotion of a scheme.
Mutual fund expense ratio also includes compliance cost and shareholder service cost of the scheme.
Why is Expense Ratio Higher for Regular Plans?
The regular plan of a mutual fund scheme always features a higher expense ratio than its direct plan counterpart because when you invest in a regular mutual fund scheme, you invest through an intermediary such as a broker, distributor or agent.
In such cases, the fund house pays a commission to the intermediary which is deducted out of your investment amount. While these costs are also associated with direct plans, the applicable charges tend to be much lower. Thus, it is always beneficial (as you get higher returns) to invest in the direct plan of a mutual fund scheme.
You can invest in a direct mutual fund scheme through Paisabazaar.com which enables you to invest in the direct variant of a mutual fund scheme without charging any commission.
Mutual Fund Charges: Maximum Expense Ratio Limits
As per capital market regulator SEBI, fund houses can charge a Total Expense Ratio (TER) subject to the following maximum limits:
|Assets Under Management of Scheme (crores)||TER for equity-oriented schemes (%)||TER for other schemes excluding Index Funds, ETFs and Fund of Funds (%)|
|Rs. 10,000-50,000||For every increase of 5,000 crore in AUM TER reduces by 0.05%||For every increase of 5,000 crore in AUM TER reduces by 0.05%|
|> Rs. 50,000||1.05||0.80|
However, SEBI allows fund houses to charge an extra 30 basis points (0.30%) in expense ratio over and above the above mentioned maximum limits for selling in town and cities beyond India’s top 30 cities. This benefit is available to fund houses only if 30% or more of new inflows into the scheme are obtained from beyond the top 30 cities. The aim of this discretion is to widen the penetration of mutual funds in tier 2 and tier 3 cities.
Mutual fund costs including expense ratio are deducted from the returns earned by a mutual fund scheme and adversely impact investor gains. Thus, the returns which an investor earns on his/her mutual fund investment is the residual and final return, i.e. it is the return adjusted for various mutual fund charges including the expense ratio.