Two important aspects of investing in mutual funds are the exit load and expense ratio. The expense ratio shows the expense investors pay to operate their mutual funds, whereas the exit load is a fee assessed to investors who prematurely redeem their units. The impact of these expenses on investment returns can be substantial.
The relationship between exit load and expense ratio, how they impact returns, and the tactics investors can use to lessen their effects will all be covered in-depth in this article. We will also talk about how crucial it is to comprehend these expenses in order to make wise investment choices, also discussing the difference between exit load and expense ratio.
What is an exit load in a mutual fund?
A fee assessed to the investor when they withdraw or sell their investment is known as an exit load. Levying an exit load is primarily done to dissuade investors from taking their money out of an investment before the lock-in period.
Based on your desired return, a mutual fund management calculates an average investment period that fits your risk tolerance. Therefore, for other current investors, the risk-return equation is altered if you withdraw your money before then. The fund levies an exit load as a penalty to treat current investors fairly.
Investors are subject to an exit load in order to prevent them from taking their money out within the designated lock-in period.
But it's important to keep in mind that not all schemes have an exit burden that applies to them. Therefore, before making an investment, thoroughly study the scheme documents.
What is the expense ratio in mutual funds?
In essence, an expense ratio is the percentage-based fee that a fund management charges you to manage your investments. The maintenance of an investment fund entails a number of expenses, including custodian expense, audit expense, administrative costs, registrar expense, transaction expense, and sales and marketing costs. It is referred to as a Total Expense Ratio (TER) in the finance industry.
Stated differently, the expense ratio is the cost per unit of maintaining an MF/ETF. The expense ratio is assessed based on the duration of your investment in the mutual fund (MF) and is charged pro rata. These expenses show up as a daily deduction from your returns, or net asset value (NAV).
For example, let's say the expense ratio of an MF is 2%.The profits on your investment will therefore be reduced by 0.0054% (2%/365) of your total investment each day.
These spending ratios are entirely governed by SEBI in India. Investors can quickly verify the cost ratio of a certain fund by visiting the websites of the Association of Mutual Funds in India (AMFI) and the AMC.
Key differences between exit load and expense ratio
| Exit Load | Expense Ratio |
| Exit load is a fee charged by mutual funds when an investor redeems their units prematurely. | The expense ratio is the annual fee charged by mutual funds to cover their operating expenses. |
| Exit load aims to discourage investors from exiting funds too soon. | Expense ratio covers costs like management expense, administrative expenses, and marketing costs. |
| Exit load is a one-time charge levied at the time of redemption. | Expense ratio is an ongoing annual charge deducted from the fund's NAV on a daily basis. |
| The exit load percentage varies across funds and can range from 0% to 3% or more. | Expense ratio is typically between 0.05% to 2.25%, with lower ratios for larger funds. |
| Exit load is directly related to the expense ratio - higher exit loads lead to higher expense ratios. | Expense ratio is not related to exit loads in terms of calculation or deduction. |
| Exit load is not charged by all funds, especially index funds and ETFs. | Expense ratio is charged by all mutual funds and ETFs to cover their costs. |
While both exit load and expense ratio are charges related to mutual fund investments, they differ in their purpose, timing, and calculation. Exit load is a one-time charge aimed at discouraging early exits, while expense ratio is an ongoing annual charge to cover the fund's operating expenses.
Why both exit load and expense ratio matter?
Exit load and expense ratio are two crucial factors that can significantly impact the returns on mutual fund investments. While they serve different purposes, understanding both is essential for investors to make informed decisions. The exit load discourages premature redemptions by charging a fee when investors withdraw their funds within a specified period. This charge directly reduces the returns earned on the investment. By holding the investment for the recommended duration, investors can avoid paying the exit load and maximise their returns.
The expense ratio, on the other hand, is an ongoing annual charge that covers the fund's operating expenses. A higher expense ratio means a larger portion of the fund's returns is used to cover these costs, leaving less for the investors. Investors should aim for funds with lower expense ratios to maximise their net returns.
Considering both the exit load and expense ratio helps investors assess the true cost of investing in a particular mutual fund scheme. By choosing funds with low charges and aligning their investment horizon with the exit load period, investors can optimise their returns and achieve their financial goals more effectively.
Formula of Exit load
The exit load is calculated as a percentage of the Net Asset Value (NAV) of the mutual fund units being redeemed.
The formula to calculate exit load is:
| Exit Load = Exit Load Percentage × Redemption Amount |
How is exit load calculated?
The exit load is calculated based on the duration for which the investor has held the mutual fund units. Typically, the exit load percentage is higher for shorter holding periods and decreases over time as the investor holds the units for longer.
For example, if a mutual fund has an exit load of 1% for redemptions within 1 year, and the investor redeems their units after 6 months when the NAV is Rs. 50 per unit, the exit load calculation would be:
Redemption Amount = 100 units × Rs. 50 per unit = Rs. 5,000
Exit Load = 1% of Rs. 5,000 = Rs. 50
Net Redemption Amount = Rs. 5,000 - Rs. 50 = Rs. 4,950
The exit load of Rs. 50 is deducted from the redemption amount, and the investor receives Rs. 4,950 as the net redemption proceeds.
The exit load percentage and duration can vary across different mutual fund schemes. Investors should carefully review the exit load structure before investing to understand the potential costs associated with early redemption. By aligning their investment horizon with the fund's exit load policy, investors can optimise their returns and minimise the impact of exit loads.
Formula of Expense ratio
The expense ratio is calculated as a percentage of the total assets under management (AUM) of the mutual fund.
The formula to calculate the expense ratio is:
| Expense Ratio = Total Annual Operating Expenses / Total Assets Under Management |
How is the expense ratio calculated?
The expense ratio is calculated by dividing the total annual operating expenses of a mutual fund by its total assets under management (AUM). The operating expenses include various costs such as management expense, administrative expense, marketing expenses, and other operational costs incurred by the fund.
For example, if a mutual fund has total annual operating expenses of Rs. 50 million and an AUM of Rs. 1 billion, the expense ratio would be calculated as follows:
Total Annual Operating Expenses = Rs. 50 million
Total Assets Under Management (AUM) = Rs. 1 billion
Expense Ratio = Rs. 50 million / Rs. 1 billion = 0.05 or 5%
In this case, the expense ratio of the mutual fund is 5%, meaning that 5% of the fund's assets are used to cover the annual operating expenses.
The expense ratio is typically expressed as an annual percentage and is deducted from the fund's net asset value (NAV) on a daily basis. Investors should carefully consider the expense ratio when selecting mutual funds, as it can have a significant impact on the overall returns of their investment.
Which is better for investors - Exit load and expense ratio?
Both exit load and expense ratio are crucial factors that impact the returns on mutual fund investments. While they serve different purposes, understanding both is essential for investors to make informed decisions.
Exit load
- Purpose: The exit load is a fee charged by mutual funds when an investor redeems their units prematurely. It aims to discourage investors from exiting funds too soon, promoting long-term investment.
- Calculation: The exit load is calculated as a percentage of the Net Asset Value (NAV) of the mutual fund units being redeemed. For example, if a mutual fund has an exit load of 1% and the NAV is Rs. 50 per unit, the exit load would be Rs. 0.50 per unit.
- Impact: The exit load directly reduces the returns earned on the investment. It is typically higher for shorter holding periods and decreases over time as the investor holds the units for longer.
Expense ratio
- Purpose: The expense ratio is the annual fee charged by mutual funds to cover their operating expenses. It includes management expense, administrative expenses, marketing costs, and other operational costs.
- Calculation: The expense ratio is calculated as the total annual operating expenses divided by the total assets under management (AUM). For example, if a mutual fund has total annual operating expenses of Rs. 50 million and an AUM of Rs. 1 billion, the expense ratio would be 5%.
- Impact: The expense ratio is an ongoing annual charge deducted from the fund's NAV on a daily basis. It reduces the returns earned by investors. A higher expense ratio means a larger portion of the fund's returns is used to cover these costs, leaving less for the investors.
Comparison
- Exit load: This charge is a one-time fee levied at the time of redemption. It is directly related to the duration for which the investor has held the units and can vary significantly across different mutual fund schemes.
- Expense ratio: This is an ongoing annual charge that covers the fund's operating expenses. It is not related to the exit load in terms of calculation or deduction. The expense ratio is typically between 0.05% to 2.25%, with lower ratios for larger funds.
Conclusion
In order to maximise returns on investment, investors must carefully consider a number of factors when investing in mutual funds. The Bajaj Finserv Mutual Fund Platform offers a wide range of investment options, including equity, debt, and hybrid funds, to cater to diverse investment goals and risk profiles with over 1000 mutual fund schemes.
