"Understanding the Costs of Investing in Mutual Funds: Expense Ratios, Transaction Fees, and More"
Mutual funds offer a popular investment option for various types of investors, including retail investors, high net worth individuals, and corporates. They provide the opportunity to invest in different asset classes such as equity, debt, and commodities. Mutual funds are often considered a safe way to invest in the capital market because they are managed by expert fund managers who can navigate market volatility effectively. Systematic investment plans (SIPs) are a widely-used investment method within mutual funds that allow investors to invest regularly and capture market swings.
While mutual funds provide diversification benefits to investors, there are costs associated with investing through this route. Fund houses incur expenses such as marketing and advertising, fund management, and administrative costs. These costs are passed on to the investors in the form of an expense ratio. The expense ratio represents the percentage of a fund’s assets that are used to cover these expenses. In India, the capital markets regulator, Securities and Exchange Board of India (SEBI), has set limits on the total expense ratio (TER) for different scheme categories.
The TER for mutual funds in India ranges from 1% to 2.25% based on factors such as the type of scheme and the assets under management. For equity-oriented schemes, the maximum TER is 2.25% for the first Rs 500 crore of daily net assets. It decreases to 2% for the next Rs 250 crore and further decreases to 1.05%. For schemes other than equity-oriented ones, the TER ranges from 2% to 0.80%. Index funds, exchange-traded funds (ETFs), fund of funds (FoFs), and close-ended and interval schemes also have varying TERs, ranging from 2.25% to 1%.
In addition to the TER, there are other costs involved in investing in mutual funds. These include brokerage and transaction costs, which the fund house incurs for executing trades in the market. The brokerage costs amount to 0.12% of the trade value for cash market transactions and 0.05% of the trade value for derivatives transactions.
There are also expenses not exceeding 0.30% of daily net assets, which are applicable to new inflows from cities beyond the top 30 cities (referred to as B-30 cities). Furthermore, schemes that have an exit load provision may have additional expenses not exceeding 0.05% of daily net assets.
Goods and Services Tax (GST) is levied on the investment and advisory fees charged by the asset management companies (AMCs). This adds to the overall costs for the investor.
Additionally, AMCs are permitted to deduct transaction charges from the subscription amount. For existing investors, a charge of ?100 is deducted, and for first-time investors, a charge of ?150 is deducted for every subscription of ?10,000 and above.
It’s important for investors to consider these costs and understand their impact on their investment returns when investing in mutual funds.