1. Want to invest in mutual funds? First understand the associated costs

Want to invest in mutual funds? First understand the associated costs

There are a variety of costs associated with mutual fund investments, which shave off a few percentage points off the investment’s returns.

Updated: June 14, 2017 3:11 PM
Investors, Liquid funds, Kaustubh Belapurkar, Liquid funds, Mutual funds, Treasury Bills, Equity Knowing about the costs associated with mutual fund investments is critical to your long-term wealth creation.

By Adhil Shetty

If you invest in mutual funds, it is imperative that you understand the associated costs. There are a variety of costs associated with mutual fund investments, which shave off a few percentage points off the investment’s returns. Knowing about these costs is critical to your long-term wealth creation. Not knowing them could mean that you miss your investment goals by wide margins.

Let’s take a look at them, and also understand how the arrival of the Goods and Services Tax will impact these costs.

Expense Ratio

Every fund mentions its Total Expense Ratio. This is a sum of all expenses incurred towards fund management, brokerage, auditing, operational requirement etc. Essentially, this is your payment to the asset management company to buy, hold, and sell securities on your behalf. For example, knowing which stocks to buy is difficult, and the arriving at the best answers requires thorough research. Therefore, these complex decisions of what and when to buy or sell is left to the expert care of the fund manager, while you reap the rewards of his decisions. The expenses are charged to your fund’s NAV at the time of redemption.

Exit Loads

Most varieties of mutual funds impose a charge to discourage investors from making premature redemptions of their units. The quantum of this load, and the tenure for which it is applicable, will be mentioned in the investment scheme document. For example, most equity mutual funds impose a 1% exit load for redeemed units whose tenure is less than one year. Debt funds also have exit loads. Liquid funds typically do not impose an exit load. Investors much carefully consider the exit load before redeeming their units.

GST Impact On Mutual Funds

Investing in mutual funds is going to get slightly more expensive with the arrival of GST. Currently, the expense ratio for mutual funds usually varies between 1.25% and 2.75%. With the revised GST rates, this would increase by 4-7 basis points. So, a TER of 1.51% would go up to 1.56%, for instance. This is a marginal increase and investors need not worry about it at the moment.

Why You Must Pay Attention To Costs

You need to research the costs of your investments well in order to understand your benefits accurately. Even a small difference of just 0.5% in your costs could mean a lot of money out of your pocket in the long term.

Let us take an example to understand this.

Let’s say you had an SIP of Rs 10,000 for 10 years where you earned a CAGR of 12%. This helped you create a corpus of Rs 23.23 lakh. But if you did the same SIP for a CAGR only 0.5% lower, your 10-year corpus would be short by Rs 68,000 at Rs 22.55 lakh.

Done over a longer tenure, the costs of the same investment would increase exponentially. The difference between a 10-year corpus and a 20-year corpus would be Rs 6.45 lakh.

 

Monthly SIP

For 10 Years

For 20 Years

12%

11.5%

Difference

12%

11.5%

Difference

Rs. 10,000

Rs. 23.23 lakh

Rs. 22.55 lakh

Rs. 0.68 lakh

Rs. 99.91 lakh

Rs. 93.46 lakh

Rs. 6.45 lakh

Rs. 15,000

Rs. 34.85 lakh

Rs. 33.83 lakh

Rs. 1.02 lakh

Rs. 1.49 crore

Rs. 1.40 crore

Rs. 9.77 lakh

The expense ratio shouldn’t be the only criterion for you to explore while buying mutual funds. You should look at a variety of factors such as long-term returns, the fund manager’s track record, AUMs, and the quality of the fund’s underlying assets.

Don’t pick a scheme just because it has a low expense ratio. If another fund with a higher expense ratio provides you greater returns and superior service, it is advisable to go ahead with it. But when in doubt, consult an investment advisor to understand your expenses and risk factors.

(The writer is CEO, BankBazaar.com)

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