Mutual Fund cost and its Impact on your Portfolio

We discussed Mutual Fund in one of my earlier blogs, but one must be assured that Mutual Funds are not free for investment i.e they do carry some associated costs with it which are levied in the percentage of investment made by the investors. So the returns shown by Mutual Fund Houses in their advertisements are not actually what the investors going to fetch but 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 how this 3.17 % is divided into various costs levied from Investors by the Mutual Fund Houses :

Types of Mutual Fund Cost

A Mutual Fund House will charge certain charges in terms of various fees or tax to the consumer which can affect the investment porfolio of consumer in the log term. Costs asscoaisted with Mutual Fund are:

Mutual Fund Cost and its impact

⇛ Capital Gain Costs:

It is the first mutual fund cost which is levied by the houses from consumer like you and me. It is charged from the Investors on the profit earned by Investors in a year and are generally of two types, one is Long Term Capital Gain Tax (LTCG) and other is Short Term Capital Gain TAX (STCG) which are applicable at the investor’s end only.

LTCG is a tax on holding the stock or Equity Mutual Funds above one year or can say if you stay invested for more than one year in particular stock or equity mutual funds. It is taxed if 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 every you are advised to retain your investment in any Mutual fund foe at least one year before making a request for redemption.

⇛ Transaction Cost:

In addition to Capital Gain Tax, another mutual fund cost associated is with every transaction or trade made by the mutual fund house, which is also borne by investors only. That means more frequent trading in stocks i.e buying and selling stocks by the house, more you are going to pay to these companies as a transaction cost. That is the reason, companies keep on trying to prompt investors to do frequent trading in direct stock picking by sending them daily analysis and all related matters.

The transaction 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 to do all these things Fund Manager must have some money in cash so that he will be able to switch funds with profitability in order and also to process the investor’s need of cash in event stock is sold by investors.

So this part of money remains with Fund Manager as idle money and 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 which is disclosed to the investor by Mutual Fund houses is actually the fees levied by that fund house for managing your money or portfolio on your behalf. That means it can be said that it is the fees for Fund Manager who is running the portfolio to produce a return on your investments. It also combines management fees, commission for distributor, registrar’s fees, and other market associated costs.

The distributor’s commission can be reduced or waived off if you are investing online in any mutual fund. TER is measured as a percentage of AUM. So, these fees can be different for different Fund Houses but SEBI put an upper cap on it like for equity MF @2.5%, for Debt Mutual Fund @ 2.25%.

Redemption fees or Exit load:

It is the mutual fund cost associated with the process of exiting from any fund and charged by the houses as a percentage of revenues earned. For Equity Mutual Fund if you want to exit within one year of an investment than you have to pay the exit load fees to the house. So simply if you are holding your investment in stock for more than one year that means you escaped from these fees.

Fund Manager’s performance:

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/chosen 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 my earlier blog, 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 since long in the past and the Fund performed well in his time than you can go for the Mutual Fund. But if Fund Manager is just new in the house than 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.

If the Fund Manager is changed after your investment got completed in the Mutual Fund House, then don’t panic and just track the performance of the company for the next 6 to 8 months.

Market volatility:

It is the main factor that is disclosed by each Mutual Fund House in very small letters to you in Terms and Conditions but this part is the driving factor 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:

Simply means loss associated with the credit process and usually incur Debt Mutual Funds. If any AMC is not able to repay the bond amount to the investors than it is a worthless investment. AMC deposit money to banks and lend money to the various companies. So money given to the government is less risky to recover than given to private companies.

The inflation:

It is obviously going to erode the value of the money earned as returns over a period of time by the investors from their investments. So ultimately the returns et reduced from the disclosed one to an investor.

So the things to note down is that Equity investment is the best for the creation of wealth but in the long term only, as for the short term you are exposed to STCG and 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 actual just because of these mutual fund cost associated with the Funds and Stocks, so you must devise a plan to cut short these small costs.

SEBI (Security Exchange Board of India) is the regulator of the commodity and security market in India and all the Mutual Fund must be registered with SEBI. SEBI can be visited through its Official website and It keeps an eye on the performance and default and accordingly provide guidance to the houses for the sake of consumers.