Most forms of investments carry costs. These costs shave a percentage off your absolute returns. Mutual fund investments are no different. If you invest in them, it is important for you to understand these costs since they have a sizeable impact on your long-term wealth creation plans. From July 1, you would also be levied the Goods and Services Tax (GST) which will further impact your investment costs.
Not knowing your costs could mean that you will miss your investment target by a margin of several lakh rupees in the long run. Let’s understand this with an example here.
WHY COSTS MATTER
A cost of one per cent may not seem like much if you are investing in a mutual fund scheme with a CAGR of 20-30 per cent consistently. However, over the long term, this small margin may cost you tens of lakhs of rupees. Let's say you ran a SIP of Rs 10,000 for 10 years and it returned a CAGR of 13 per cent. Let’s provide a nominal expense ratio of one per cent. This brings down your absolute returns to 12 per cent. At the time of redemption, your corpus will be lighter by Rs 1.43 lakh in 10 years, or Rs 14.09 lakh in 20 years.
So, what are all the expenses that you incur towards your mutual fund investments? Let’s take a look.
TOTAL EXPENSE RATIO
Whenever you invest in a mutual fund scheme, you must take note of its total expense ratio, which is the sum of all expenses that an asset management company (AMC) incurs towards managing the fund. AMCs invest in several kinds of securities such as bonds and stocks. The complex job of deciding which securities to buy, hold, or sell rests with the fund manager, who must use all his financial expertise to get your fund the best possible returns. For this service, the fund manager charges a fee, which constitutes the expense ratio. The ratio will also include costs incurred towards agent commissions, brokerage, audits, and operations. When you redeem your mutual fund investment, the expense ratio is charged to the prevailing NAV at the time. The quantum of the expense ratio is tightly regulated by the Sebi, and is decided by the average weekly net assets under management for a scheme. Typically, debt funds have lower expense ratios than equity funds, while passively-managed funds such as ETFs don’t have them.
GST IMPACT
With the arrival of the GST, the service tax charged on the expense ratio would rise marginally. Before GST, the typical expense ratio varied between 1.25 per cent and 2.75 per cent. With the GST, investors can expect to pay 4-7 basis points higher. This is a small increase that is unlikely to pinch most retail investors.
EXIT LOADS
AMCs discourage investors from pulling out of their schemes prematurely. One way they do it is by imposing an exit load — an expense charged as a percentage of the redeemed mutual fund units. For example, most equity funds will impose a load of one per cent, if you exit your units before the completion of 12 months. Debt funds may have smaller exit loads — for example, 0.25 per cent if redeemed within three months. One class of mutual funds that typically don’t have an exit load are liquid funds, which help investors park their money temporarily. Before you invest in a scheme, consider its exit load to understand what a premature redemption would cost you.
WHAT INVESTORS CAN DO
Expense ratios and exit loads are just two of the things that savvy investors consider while investing in mutual funds. A wholesome view of a scheme’s long-term performance, fund manager’s record, AUMs, and the nature of underlying assets must be taken. Schemes with lower expense ratios may not necessarily be the best ones for you.
Savvy investors also have the option of buying direct mutual fund plans. Most mutual fund schemes have a regular variant (sold by distributors and agents) and a direct variant sold by AMCs. Direct plans have a lower expense ratio due to the absence of agents. These are best for investors who can do their own research and don’t need to be guided by agents.
When in doubt, consult your investor advisor, and always read your scheme document thoroughly before investing your hard-earned money.
The writer is CEO, BankBazaar.com
