When investing in mutual funds, investors tend to only look at the returns. However, it also pays to be aware of what the fund is charging you.
The cost structure is set by the mutual fund regulator, the Securities and Exchange Board of India.
Here we give you the actual cost of investing in a fund.
One-time loads
Entry load is the fee you pay when you buy the units of a fund. It is a percentage of the amount you are investing.
Let's say the entry load is 2.25%. That means if you invest Rs 5,000, Rs 112.5 will be the fee you pay. The balance will be invested and you will be given units accordingly.
The question arises as to what happens in a Systematic Investment Plan where you invest fixed amounts every month. Some funds charge an entry load for every single investment.
Let's say you put in Rs 2,000 every month via a Systematic Investment Plan. And the load is 2%. That means Rs 40 will be the load and Rs 1,960 will be invested.
The next month, you put in another Rs 2,000. From this amount, Rs 40 will again be deducted. But the Rs 2,000 you put in earlier will not be touched. So, the load will not be on Rs 4,000 but only on your fresh investment of Rs 2,000.
Exit load is the fee you pay when you sell the units of a fund. It is a percentage of the total amount you will get when you sell the units of a fund.
Contingent Deferred Sales Charge is an exit load charged in particular circumstances. For example, Fidelity Equity Fund charges a load of 1% if you sell your units within 180 days of buying them. If you sell it after that, you pay no load. In technical terms, the 1% is referred to as a CDSC.
This is the charge from which the mutual fund meets its selling and distribution expenses on an ongoing basis. The maximum load that can be charged is 7%. Today, the highest load is 2.25%, which is charged for equity funds.
Generally, if a fund charges you an entry load, it will not charge you an exit loan. They tend to charge just one load.
Recurring expenses
These are the expenses incurred of running a fund. These involve a broad array of expenses like fund management fee, expenses for running and maintaining a mutual fund, selling and promotion expenses. All these fall under a single basket called 'expense ratio or annual recurring expenses' that is disclosed every March and September.
So if you want to see how 'expensive' your fund is, you can check the expense ratio.
The maximum recurring expenses that an equity fund can charge is 2.5% of the average daily net assets.
The fund can charge 2.50% for the first Rs 100 crore of assets under management, 2.25% for next Rs 300 crore and 2% for the next Rs 300 crore; all funds handling more than Rs 700 crore can charge 1.75%.
This expense is calculated on a daily basis and the Net Asset Value that you see is what is declared after the expenses are deducted. So, while the expense is calculated and levied every single day, it is declared only in March and September.
Since this is charged regularly, a high expense ratio over the long-term may eat substantially into your returns.
Initial issue expenses
Also known as new fund offer expenses, this is an expense which fund houses charge at the time of launching a fund. This is subject to a maximum of 6% of the amount raised during the new fund offer period.
This expense is amortised over a period not exceeding five years. That means this expense amount is distributed over the five years and not charged in the first year itself.
However, as per a recent SEBI guideline, open-ended equity funds can no longer do this (close-ended funds can). They will have to meet the expenses from the load itself.
Open ended funds are those which allow you buy units from the fund house and sell it back to them anytime. Close ended funds come out with a fixed time frame, say five years. They only sell units for a fixed period of time when the fund is launched. After that, they are closed for issuing new units. But, they list on the stock exchange for those wanting to sell units or they offer to buy back units at specific times during the period of the fund (in this example, five years).
So open-ended schemes may now increase the entry load to help them incur these costs.