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What is the cost of investing in equity mutual funds

28 Jun 2023

Did you know the costs involved in investing in mutual funds. In the old days the only cost that investors in equity funds realized was the entry load that was debited to their account at the time of investing in equity funds. However, post 2009 SEBI had banned the explicit charging of entry loads on mutual funds if the investor opted for direct investment option. However, there are still costs that equity fund investors have to contend with. What are the costs of investing in equity mutual funds? Let us look at the mutual funds fees and expenses while investing in mutual funds. Also, understanding mutual funds fees and expenses are the key to evaluating your effective returns. Here are some of the key costs that you bear when you invest in equity funds.

1.  Entry loads and upfront transaction costs

Entry loads were a charge on equity funds at the time of investing. This was normally used to defray the cost of marketing and distribution of mutual funds and it used to range from 2% to 2.25% in the case of equity funds. This entry load was banned by SEBI in 2009. However, the regulator has permitted the fund to levy a fixed charge as transaction fee on the quantum of funds invested. For an investment up to Rs.10,000 no fee can be charged. If the investment is more than Rs.10,000 then the fund can impose a Fee of Rs.150 as a one-time charge. This will be applicable for new investors and for existing investors this fee shall be limited to Rs.100. If it is a SIP with a total commitment of Rs.10,000 to the SIP then a nominal fee of Rs.100 can be charged which will be defrayed in four equal instalments from the 2nd to the 5th instalment.

2.  Exit Load on early exit from an equity fund

Exit load is imposed by most funds to encourage equity fund investors to take a more long-term view. When investors book out before 6 months or 1 year, the loyal investors who stay invested tend to subsidize the exiting investors. To prevent this anomaly, the fund is allowed to impose an exit load if the investor is exiting early. Normally, equity funds impose exit load if the exit is before a period of 1 year. The exit load varies between 1% and 3% and is normally closer to 1%.

3.  STT on mutual fund redemption

When equity funds are redeemed, securities transaction tax has to be paid on the sale amount. This amount is imposed at the same rate as is imposed on equity sales in the equity markets. When the funds are redeemed, irrespective of the holding period, the STT is deducted from the redemption amount and only the balance is credited to the bank account of the equity fund investor. 

4.  The all important Total Expense Ratio (TER)

This is perhaps the biggest and most important cost that the equity fund investors have to bear. What is TER? The fund needs to incur a plethora of costs like administrative costs, fund management costs, legal fees, auditor fees, registrar fees, brokerage, as well a STT on purchase and sale of equities. Obviously, these costs cannot be borne by the AMC and is debited to the corpus. The SEBI stipulation for TER is as under:

Average Weekly AssetsLimit for Equity SchemesFirst Rs.100 crore of equity fund AUM2.50%Next Rs.300 crore of equity fund AUM2.25%Next Rs.300 crore of equity fund AUM2.00%Balance assets above Rs.700 crore1.75%

While these are annual costs, the proportionate cost is allocated on a daily basis and debited to the end-of-day NAV so that the NAV reflects a clear picture of the net asset value of the fund.

5.  Tax implications on dividends

Till the Union Budget 2018, dividends declared by equity funds used to be tax free in the hands of the investor and there was no dividend distribution tax (DDT) when the fund declared dividends. However, post the Union Budget 2018 the dividends will continue to be tax-free in the hands of the investor but there will be DDT when the fund declares the dividend. This DDT will be deducted at the rate of 11.648% (10% tax + 12% surcharge + 4% cess) and only the net amount will be paid to the investor.

6.  Tax implications on capital gains

Here again there has been an important change in the case of taxation of capital gains in the Union Budget 2018. Till the fiscal year 2018-19, the short term capital gains on equity funds were taxed at 15% while LTCG was entirely tax-free. Effective, fiscal year 2018-19 all long term capital gains on equity funds above Rs.1 lakh in any fiscal year will attract flat 10% tax rate. This tax will be imposed without any benefit of indexation notwithstanding the holding period.

Investing in equity funds has a lot of cost implications which you need to factor in to get a proper perspective of your effective yield!

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