Investing in mutual funds (MFs) is better than going directly to the stockmarket as your money is professionally managed, your portfolio is diversified and you don't have to go through the hassle of choosing the right stock or bond to invest in. There are experts to do the job for you. But all this comes for a price.
In the first of our two-part series on expenses, we take you through two key front-end charges that you pay while buying MF schemes.
Entry load
When you invest in an ongoing MF scheme, you are required to pay a one-time, front-end charge - a percentage of the applicable net asset value (NAV) - over and above your scheme's NAV. Called the entry load, this sum is typically passed on to the agent as his commission. Assume you invest in a scheme whose NAV is Rs 50 and entry load 2.25 per cent. The price at which you will buy (sales price) its units will be Rs 51.13. While Rs 1.13 will be passed on to the agent, the balance Rs 50 will be deployed in the markets. Your investment will start growing from Rs 50 and not Rs 51.13 - the price you paid. The formula used to calculate sales price for a fund with entry load is: sales price = applicable NAV x (1+entry load in fractions).
Remember that if you enroll for a systematic investment plan (SIP), entry loads will be imposed on all your instalments.
How much
The Securities and Exchange Board of India (Sebi) stipulates that MFs cannot charge an entry load of more than 7 per cent of their prevalent NAV. Entry loads are typically decided by competition - if one MF raises its entry load, others usually follow. For instance, before 2005, MFs did not charge entry loads for SIPs. But, after a few fund houses imposed entry loads of 1.25 per cent in 2005 - and raised them to 2.25 per cent in 2006, others did the same. Almost all equity MFs now impose an entry load of 2.25 per cent on one-time as well as SIP investments.
What about no-load funds?
Only one MF - Quantum MF - does not impose an entry load. It's maiden and only equity fund till date - Quantum Equity Fund - is India's first no-load fund. Quantum MF does not impose an entry load as it avoids distributors to sell its funds. All you need to do is download the form from its website, fill it, and send it along with your cheque to the fund house. No-load funds are not yet popular in India, though it can save costs. You invest Rs 3 lakh in a scheme with 2.25 per cent entry load. Growing at a compounded annualised return of 15 per cent, your returns after 10 years would be Rs 11.86 lakh. But had you invested the same amount in a no-load fund, you would have got Rs 12.13 lakh back after 10 years.
New Fund offer (NFO) expenses
The expenses incurred during the launch of a scheme are initial issue expenses or NFO expenses. Sebi regulations mandate that closed-end funds can charge up to 6 per cent as NFO expenses. These expenses are then amortised over the closed-end period of an MF. For instance, if the tenure of a closed-end MF scheme is five years, it will amortise its entire NFO expense over five years. This means that if you invest Rs 100 in a 5-year, closed-end equity fund that charges 6 per cent NFO expenses, Rs 6 will go towards meeting the fund expenses incurred during the launch campaign. The remaining Rs 94 will be deployed in the markets. Your money will grow from Rs 94, and not from Rs 100 that you had invested.
Thanks to Sebi's April 2006 directive, open-ended NFOs are banned from charging NFO expenses; they have to meet their NFO expenses through entry loads. Closed-end NFOs cannot charge entry loads.
