Mutual Funds are investment vehicles that pool money from many investors and invest in securities like equity, bonds, and money market instruments and so on. Investors buy units of the scheme and participate in the gains or losses of the mutual fund in proportion to their shareholding.
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Companies managing the investments are called Asset Management Companies (AMCs) or simply Mutual Funds. AMCs charge certain fees on mutual fund schemes from the investors. It is important to have an idea on what these charges are, because they can impact your earnings. Broadly, there are two types of fees that a Mutual Fund charges:
One-Time Charges and Recurring Charges
1. One-Time Charges
Entry Load – The fees paid at the time of investing in a Mutual Fund Scheme is called the Entry Load. It is a one-time charge that can increase buying cost. Securities and Exchange Board of India (SEBI) has abolished entry load for mutual funds in India.
Exit Load – It is the charge levied at the time of exiting or leaving a scheme before a stipulated time. Exit loads were originally designed to discourage an investor form leaving the scheme because of the charges to be paid. It is calculated as a percentage of the Net Asset Value (NAV). Different schemes have different rates for the exit load.
For an equity fund with current NAV of Rs 120 per unit, the exit load may be 1%. In this case the actual redemption value will be 120 – 1.2 = 118.8.
Transaction Charges – This type of charge is paid when investing in a mutual fund through an intermediary or distributor. In case you invest in a mutual fund directly, there are no transaction charges involved. For first-time investors, mutual fund houses charge Rs 150, and for existing customers, the charge is Rs 100, for a one time investment of Rs 10,000 or more. For investment through SIP, if the amount is Rs 10,000 or more, transaction charges will be levied in 3 or 4 instalments.
2. Recurring Charges
It is known as the Total Expense Ratio (TER), and charged as a percentage of average assets under management. It is the total cost an investor has to bear, while investing in a mutual fund scheme. Charges like fund management fee, advertising expenses, custodian’s fees, and registration fees are all included in the TER. AMCs cannot charge TER as per their wish, but must follow the rates specified by the regulatory body SEBI.
Earlier, employees of Public Sector Banks (PSBs), would cross-sell mutual funds and other financial products and earn commission, incentives, and rewards. The Ministry of Finance (MoF) has advised heads of public sector banks (PSBs) not to pay the commission on cross-selling to the employees. This commission is to be treated as income for the bank. This potentially discourages the employees from selling or promoting mutual funds, as they no longer earn any incentives.
In an attempt to make investing in mutual funds more affordable, SEBI lowered the TER on MFs. With this move, it becomes easier to invest in Mutual Funds and also improves the returns to the investor. SEBI has also asked mutual fund houses to disclose their TER of schemes on a daily basis.
The new TER applicable is as follows
SEBI has also instructed that the mutual fund industry must adopt the full trail mode of commission without payment of any upfront commission. An upfront commission is paid to the broker or mutual fund distributor, within a month of customer’s purchase of mutual fund investment. Trail Commission is paid regularly to the distributors as long as the person remains invested in the mutual fund. SEBI has asked Mutual Funds to disclose the commission payment in their half yearly consolidated account statement. This allows the investors to know the exact amount being paid as commission.
How do the changes affect my Earnings?
Since TER is a recurring charge that is levied each year, higher TER can eat into the earnings in the long run. A simple example would be to consider a fund that earns returns of 15% a year. If the TER is 2%, then the effective rate of return for the investor is only 13%. It is clearly seen that a higher TER will reduce your earnings and vice versa. Ordinary citizens who have invested in mutual funds or are looking to invest can take this opportunity to invest and earn higher returns. In the long run, the reduced TER will prove to be a large increase in the earnings.
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