All you should know about the costs of investing in a mutual fund

What are the charges involved in mutual fund investing?

Investing in mutual funds gives you the advantage of professional fund management. For every mutual fund scheme, the fund house appoints an experienced fund manager who handles your investment portfolio on your behalf. As a result, there are expenses involved in such kind of an arrangement which the fund house charges from the investor. You may regard these charges as costs of investment. Being a mutual fund enthusiast, you need to be aware of all the costs involved in mutual fund investment. Broadly, these charges can be classified as one-time expenses and recurring expenses.

One-time expense

The one-time expenses essentially includes various loads which the fund house levies when investors make a buying or selling transaction. These are as follows:

a. Transaction charges

One time expense like transaction charge occurs at the time of investment. You attract transaction charges when you invest in mutual funds through an intermediary like a mutual fund distributor. Such an expense does not occur when you invest directly in the funds. As per Sebi mandate, the first time investors are charged Rs 150 from the one-time investment of Rs 10,000 and above by the fund house; which are payable to the distributor. Existing investors are charged Rs 100 for the same. If you are going by the SIP mode, transaction charges will be levied in 3 to 4 installments if the investment commitment is Rs 10000 and above. 

b. Entry load

The fund house charges entry load from the investor when he/she purchases units of a mutual fund scheme. Such a load is used to reduce the amount of invested capital in the scheme. Thus, as per Sebi mandate, this practice has been scrapped and mutual funds cannot levy any entry load.

c. Exit load

The fund house charges an exit load when you redeem units of a mutual fund scheme. It is expressed as a percentage of prevailing fund value on the date of redemption. Such a load varies from one scheme to another and isn't constant across funds. Exit loads are charged when the investor exits the fund within the lock-in period. However, once the lock-in period gets over, the investor can redeem the units without attracting any loads. The main idea behind such loads is to encourage investors to stay invested for the lock-in period. 

Recurring expenses

These expenses are charged as a percentage of the average asset under management of a particular mutual fund scheme. It is known as the Total Expense Ratio (TER). Sebi has specified the upper limit which the fund houses can charge from the investors. It is 2.5 per cent for the equity funds and 2.25 per cent for the debt funds. TER of all the mutual funds differ based on the size of the fund and exposure to equity. Ideally, as the fund grows in size, the expense ratio should reduce owing to benefits of economies of scale. 

Do these charges affect your returns?

Expense ratio of a mutual fund scheme has a direct impact on fund returns. The fund declares its net assets and Net Asset Value (NAV) after deducting the expenses. A higher expense ratio translates into higher charge on fund's assets and lower fund returns. Consider Fund A and Fund B which have delivered 12 per cent returns in the past 3 years. Their expense ratios are 1 per cent and 1.5 per cent respectively. Consequently, returns after adjusting for expenses will be 11 per cent and 10.5 per cent respectively. Thus, owing to a lower expense ratio Fund A generates higher take home returns than Fund B.

The bottomline

While shortlisting mutual funds, you may compare these on the basis of expense ratio as well. Choose a fund which gives higher returns at relatively lower cost of investment.

Archit Gupta is Founder & CEO of ClearTax