We discussed Mutual Funds in my earlier blogs, but you must be assured that Mutual Funds are not free to invest. Mutual Fund fees and charges are levied on the percentage of investment made by the investors. The returns shown by Mutual Fund Houses in their advertisements are not actually what the investors would get but it is actually less than that.
Tony Robbins wrote beautifully in his book “Money- Master the Game” that
“The Real Cost of owning a mutual fund is about 3.17 % to the investor“
So we should discuss how this 3.17 % is divided into various costs levied from Investors by the Mutual Fund Houses.
Table of Contents
Types of Mutual Fund Fees and Charges
A Mutual Fund House/AMC charges certain charges in terms of various taxes to the consumer which can affect the investment portfolio of the consumer in the long term. Different Costs associated with Mutual Funds are:
Capital Gain Costs:
It is the first mutual fund cost that is levied by the AMC from consumers like you and me. It is charged from the Investors on the profit earned by Investors in a year and is generally of two types, one is Long Term Capital Gain Tax (LTCG) and the other is Short Term Capital Gain TAX (STCG) which are applicable to the investors.
LTCG is a tax on holding an investment above one year and you will be charged on the income generated from the investments made for more than one year longer. You can say that if you stay invested for more than one year in a particular stock or equity mutual fund, LTCG will be applicable to the returns of that particular investment. It is taxed if the total income in a year is above one lakh rupees.
While STCG is a tax on holding the stock for less than one year. LTCG is normally very less as compared to STCG, so you are advised to retain your investment in any Mutual fund for at least one year before making a request for taking out your investment.
Transaction Cost:
In addition to Capital Gain Tax, Transaction tax is another mutual fund cost associated with every transaction or trade made by the mutual fund house, which is also borne by investors only. It means the more frequent trading in stocks i.e buying and selling, the more you are paying to these companies as a transaction cost. That is the reason, companies keep on trying to prompt investors to do frequent trading indirect stock picking by sending them daily analyses and all related matters.
This mutual fund cost on the investor can be ranging between 1 – 1.2 %. So it is advised that you must invest and stay for a while in any stock or Fund and if possible go for long-term holding, it will save you from the occurrence of transaction costs frequently.
Cash Drag:
The Fund Manager is one, who has to cater to all the needs of AMC as well as of investors like producing returns by switching over to profitable stocks, redemption requests, etc. So a fund manager must have some money in cash to do all these things. By this, he will be able to switch funds with profitability in order and also to process the investor’s need for cash in the event stock is sold by investors.
This part of money remains with Fund Manager as idle money and is not invested in the market, which ultimately reduces the returns generated by the full investment. So the return of investors gets further reduced by an extent of 0.8% of investment sometimes.
Total Expense Ratio:
It is the only mutual fund cost that is disclosed to the investor by Mutual Fund houses. It is actually the fees levied by that fund house for managing your money on your behalf. That means it is the fees for Fund Manager who is running the portfolio to produce a return on your investments. It also includes management fees, commissions for distributors, registrar’s fees, and other market-associated costs.
The distributor’s commission can be reduced if you are investing online in any mutual fund. TER (Total Expense Ratio) is measured as a percentage of AUM (Assets Under Management). So, these fees can be different for different Fund Houses but SEBI put an upper limit on it for equity Mutual funds which are @2.5%, and for Debt Mutual funds it is @ 2.25%.
Redemption fees or Exit load:
It is the type of mutual fund cost associated with the process of exiting from any fund and charged by the mutual fund houses as a percentage of revenues earned. In the case of Equity Mutual Fund, if you want to exit within one year of an investment then you have to pay the exit load fees. So if you are holding your investment in stock for more than one year that means you escaped from these fees.
Fund Manager’s Role:
The returns of the Mutual Fund largely depend on the Fund Managers’ performance as well. This may be because of either underperformance of the Stock or else he picked the wrong stock itself. Another reason may be that the Fund Manager concentrated all the investment with single stock and did not comply with diversification strategies So ultimately all these factors will reduce the returns generated to investors.
So as discussed in the blog about fund managers, you must watch for the Tenure of the Fund Manager with the Fund house in which you are planning to invest beforehand. If Fund Manager is associated with the fund for a long in the past and the Fund performed well in his time then you can go for the Mutual Fund. But if Fund Manager is just new in the house then you must give a break of 6 to 8 months to him and keep tracking the performance of the company, if the fund performs well then you can invest with that.
But, If the Fund Manager is changed after you did your investment in the Mutual Fund House, then don’t panic and just track the performance of the company for the next 6 to 8 months. But a fund manager is paid well to perform all these actions which are made to him out of the investor’s pocket, so it also gets added to another mutual fund cost.
Market volatility:
Market volatility is the main villain in the investment part that is disclosed by each Mutual Fund House in very small letters to you in the Terms and Conditions. But the volatility of the market is the driving force behind your returns. The market can fluctuate which depends on various factors like Inflation, political crisis, Natural Disasters, etc. So this factor of Market Volatility may also reduce the returns to investors.
Credit Risk:
It is the loss associated with the credit process and usually incurs Debt Mutual Funds. If any AMC is not able to repay the bond amount to the investors then it is a worthless investment. AMC deposits money to banks and lends money to various companies. So money given to the government is less risky to recover than that given to private companies.
The inflation:
It is obviously going to erode the value of the money generated by the investors from their investments over a period of time. So ultimately the final returns get reduced further.
You may find it useful:
Why are people afraid to invest in the Stock Market?
Final Words
So the thing to note down is that Equity or Stock Market investment is the best for the creation of wealth but in the long term only, as for the short term you are liable to pay taxes such as STCG, exit load plus other fees. The returns which are shown by the Mutual Fund Houses to you before the investment is not what you are going to get in actuality.
SEBI (Security Exchange Board of India) is the regulator of the commodity and security market in India and all Mutual Funds must be registered with SEBI. SEBI can be visited through its Official website It keeps an eye on the performance and default and accordingly provides guidance to the houses for the sake of consumers.