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Mutual funds are widely considered a simple and transparent route to wealth creation. However, newcomers and young professionals may overlook the fine print, which can slowly erode returns over time.
Understanding hidden costs is crucial for making sound decisions, choosing the right mutual fund, and maximising the value of your mutual fund investments. Here’s a simple guide to the various costs involved in mutual funds.
Expense ratio
Every mutual fund has an expense ratio. This covers the costs of fund management, administration, and distribution. This fee is deducted as a percentage of the investor’s investment, ranging anywhere from 0.5% to 2.5% per year.
While these numbers might appear small, they can considerably reduce an investor’s final corpus over decades of investing. Less expensive funds, such as index mutual funds, usually have lower expense ratios than actively managed funds.
Exit loads
Some mutual funds charge an exit load. Exit loads are fees applied when units are redeemed before a set deadline, typically within one year. These fees usually range from 0.25% to 2% and can come as a surprise when investors need to access their corpus during emergencies.
Another fee to consider is an entry load, which is deducted when an investor purchases units of a fund. Although mutual funds in India no longer charge this fee due to regulatory changes, some international or specialised funds may still impose it.
Transaction and other hidden costs
Transaction costs include brokerage fees, stamp duty, and Securities Transaction Tax (STT) that a fund incurs when buying or selling securities. While these charges are not levied directly on investors, they reduce the Net Asset Value (NAV) and, consequently, total returns.
Funds with high turnover, which frequently buy and sell assets, tend to incur higher transaction costs, making them less efficient than lower-turnover options.
Distribution and advisory charges
Commission fees paid to distributors and advisors are often hidden within the expense ratio. While these charges may seem reasonable for guidance and support, mutual fund plans that offer direct access allow investors to bypass intermediaries and avoid these fees. Choosing a direct plan can significantly boost long-term net returns.
Tax considerations and lost opportunities
Mutual funds may offer tax benefits, but investors must also account for capital gains, dividend distribution tax, and opportunities for tax harvesting.
Holding higher-cost funds can also reduce the compounding effect, as every rupee lost in fees is a rupee not earning additional returns.
How to uncover hidden costs
To minimise hidden costs in mutual fund investments:
- Always read the scheme document or Key Information Memorandum (KIM) carefully.
- Compare turnover ratios, exit loads, and expense ratios across similar funds.
- Opt for direct plans over regular plans to enhance net returns.
- Use online tools and calculators to simulate costs and payback scenarios before investing.
Conclusion
Investors who educate themselves about hidden charges become more confident and capable of achieving their financial goals. It’s important to remember that investing in the best mutual funds is a powerful route for building wealth, especially when fees are transparent and well understood. So, invest wisely.
