Retail investors must understand the costs related to investments which will have a significant impact on returns. Higher expenses paid will reduce the amount of money invested in the scheme or instrument, lower the compounding benefits and impact the overall value of the corpus in the long run.
Mutual fund expenses which are deducted from investments, direct payments such as brokerages, indirect expenses such as commission for life insurance policies and even churning the portfolio can eat into investors’ returns. Avoid paying late payment penalty for insurance premium, systematic investment plans, public provident fund and recurring deposits.
Sushil Jain, CEO, PersonalCFO.in, says awareness regarding investment expenses is increasing as these have a huge impact on the corpus in the long run. “Various investment expenses may cost around 10% of the total corpus if you invest for 20 years,” he says.
Go for a direct mutual fund plan, passive funds
For actively managed equity mutual funds, the Total Expense Ratio (TER) ranges between 1.5 to 2.25% and for debt funds it is 1.25-2%. Direct plans have a lower expense ratio than regular plans as there is no distributor/agent involved. The lower the expense ratio of a scheme, the higher the NAV. Thus, TER is an important parameter while selecting a mutual fund scheme. If one invests through a bank that is registered as a distributor then he would be investing in a regular plan with higher expense ratio and not a direct plan with lower expense ratio. However, if the bank is a Registered Investment Advisor, then the investment could be in the direct plan.
In the direct plan, the investor will have to understand the investment strategy and select the fund himself, do the KYC online and even go for online redemptions. The expense ratio is deducted from one’s investment and the Net Asset Value (NAV) is published. Investors can opt for passive funds if the fund manager of active funds is not able to generate at least 2% to 3% more returns than the passive funds.
Look before buying life insurance
All traditional life insurance plans come with high costs in terms of commission in the initial years of the cover. Most life insurers pay 60%-75% of the first year premium and another 15% for every renewal as commission. The commission is paid after deduction from the premium and the rest is invested. As a result, traditional life insurance plans offer suboptimal returns of around 5%. Even exiting a traditional life insurance policy will entail a hefty surrender charge. For life insurance, the breadwinner should opt for a term plan which is cost-effective and can take care of the family’s needs in case of any eventuality. Insurers offer discounts on online plans as they can save on commissions and other service costs.
Avoid churning of portfolio
Every time an investor churns (buys or sells) his portfolio to save tax, the overall return gets impacted as equity investments held for a longer period fetch higher returns. Each time an investor churns the portfolio (either buy or sell), he pays a brokerage of 0.5-0.75% of the transaction value, apart from depository expenses and a transaction fee levied by the stock exchange. So, an investor must look at the net returns on the portfolio, rather than the tax outflows alone.
Brijesh Damodaran, managing partner, BellWether Associates LLP, says churning typically involves buying and selling at frequent intervals. “When you buy and sell, there could be an exit load. Also at each transaction (buy and sell), expense ratio based on the asset under management of the fund gets into the transaction cost. Also, short term or long term capital gains can kick in based on the time horizon,” he says.
Jain says churning is not at all advisable as the cost of churning is more than the net additional return one expects to generate. “Costs such as exit loads, capital gains tax and losing out on the benefits of compounding will impact the reinvestment in the long run,” he says.
For actively managed equity mutual funds, the Total Expense Ratio (TER) ranges between 1.5 to 2.25% and for debt funds it is between 1.25 to 2%
Most life insurers pay 60 to 75% of the first year premium and another 15% for every renewal as commission
Churning the portfolio leads to brokerage charge of 0.5-0.75% of the transaction value apart from depository expenses and a transaction fee levied by the stock exchange