What Does Your Mutual Fund Cost You?

While Mutual Funds remain an attractive investment option, the real impact of deductions such as Expense Ratio and taxes may not be apparent to first-time investors.

In this article, we will take a look at the various charges that you have to incur on your Mutual Fund investments. Since GST is going to be implemented in July, let us also look at its impact.

Expense Ratio

Mutual Fund investments incur various costs. All of them come under a generic term called the Expense Ratio, which is the management fee and other expenses incurred in running the Mutual Fund for you.

The fund manager is responsible for buying, holding and selling the securities in which your money is invested. For his services, investors pay him a fund management fee out of your investment.

Apart from fund management fees, costs associated with administration, sales, and all other aspects of Mutual Fund operation are charged to the investor.

The Expense Ratio can be anywhere between 1% and 3% depending on how actively the fund needs to be managed. An equity-oriented Mutual Fund, for example, requires active fund management through regular buying and selling of equities. Hence, the Expense Ratio is higher. If the equities are largely from mid or small cap, the fees could be even higher.

A balanced fund or bond fund can have a lower Expense Ratio because of the presence of fixed income instruments that have undergone a credit rating process, which makes it easier for the fund manager to decide what to buy.

Furthermore, the Expense Ratio would be higher for a ‘regular’ variant of a fund as compared to its ‘direct’ variant. This is to accommodate the brokerage charges of distributors. Direct funds, on the other hand, are sold by an Asset Management Company (AMC) directly to the investor.

GST Impact

The GST framework envisages an 18% taxation on the financial industry. This is an increase of 3% in absolute terms from the earlier 15%. Needless to say, this will impact investors as this extra burden will be passed to the investors.

With the GST, there’s expected to be a minor increase in the cost to the investor. The expense ratio is expected to rise by 4-7 basis points. (One hundred basis points equals one per cent.) This isn’t something investors need to worry about.

Exit Load

Most Mutual Funds impose an exit load to discourage investors from redeeming investments in the short term. For example, equity Mutual Fund units redeemed after a tenure of less than 12 months would typically be at the cost of an exit load of 1%. The tenure and exit load imposed vary from fund to fund. You must examine your fund’s fact sheet to understand your costs.

How Your Returns Are Impacted

Any expense incurred by AMCs on running the Mutual Fund operations are passed on to the customer. Thus, your overall return will be impacted. A higher expense ratio results in lower returns. Even a difference of 2% can create a significant deviation from expected returns from a long-term investment.

Let’s look at an illustration.

A Systematic Investment Plan (SIP) of Rs 10,000 per month in a Mutual Fund, if done without any break for 10 years, will accumulate approximately Rs. 23.23 lakh, assuming the annual rate of return is 12%.

Now, consider another scenario. The Mutual Fund is the same, as is the monthly SIP amount. The only difference is the expense ratio, which goes up by 0.5% thus, reducing the returns by the same quantum.

The absolute return on investment is 11.5%. In this case, the accumulated amount in 10 years will be Rs. 22.55 lakh, making the investor poor by Rs. 68,000.

For longer durations, or for bigger investments, the difference will only compound. If the investment horizon is 20 years, the difference will be as high as Rs. 6.45 lakh.

Your fund’s expense ratio impacts your long-term returns significantly. In the short term, the fund’s exit load may diminish your returns. Therefore, pay close attention to these details during investment and redemption.

(The writer is CEO, BankBazaar.com)