The word ‘load ‘ in the mutual fund context refers to the fee charged by an asset management company that an investor pays when buying or redeeming mutual fund units. The entry load in mutual fund investments is expressed as a percentage of the initial investment amount, whereas the exit load is a percentage of the redemption amount. While SEBI has abolished entry loads, exit loads can still leave a mark on your investment. Here, we’ll take an in-depth look at entry and exit load in mutual funds.
What is an Entry Load in Mutual Funds?
Entry Load in Mutual Funds refers to the fee charged by asset management companies when investors enter a scheme for the first time. Because the fee is charged upfront, this type of load is also sometimes called the front-end load. The purpose of this fee is to cover the company’s distribution and administrative costs. For example, if you invest Rs. 10,000 in a mutual fund scheme with a 2.25% entry load, Rs. 225 will be deducted as the entry load and you will only be able to buy Rs. 9,775 worth of units.
In August 2009, the Securities and Exchange Board of India announced that investors won’t need to pay any entry load when making mutual fund investments. There are a couple of good reasons why they abolished this fee, but most importantly, the removal increased the transparency in the payment of commissions to fund distributors. This change helped make sure that a distributor’s payment is based on the quality of service they provide, which ultimately means distributors need to offer better services to investors to earn good compensation.
The move thus helped eliminate distributors who acted dishonestly or without the investor’s best interests in mind. Before the entry load was abolished, investors were paying a fee between 2% to 2.5% when buying a fund’s units. SEBI estimates that within the first year, this change saved almost R. 1,300 crores of investors money.
How Entry Load Affects Your Investment
Asset management companies used to charge investors an entry load between 2% to 2.5%. Let’s have a look at how this affects the number of units of a mutual fund scheme you can purchase. Imagine that you invest a lump sum of Rs. 10 lakh in an equity mutual fund, where the AMC charges an entry load of 2.5%. On the day of investment, the net asset value of the fund is Rs. 50. Check out the following two scenarios:
Scenario A – AMC charges an entry load:
2.5% of Rs. 10,00,000 will be deducted = Rs. 25,000
Amount invested = Rs. 10,00,000 – Rs. 25,000 = Rs. 9,75,000
Number of units you buy = 9,75,000 / 50 = 19,500 units
Scenario B – AMC does not charge an entry load:
In this case, the full amount can be used to buy the units, so
The number of units you buy = 10,00,000 / 50 = 20,000 units
Between Scenario A and B, there is a difference of 500 units. As the value of your investment grows over the years, this difference can immensely impact your returns.
What is an Exit Load in Mutual Funds?
On the other hand, exit load in mutual funds refers to the fee charged by mutual fund houses when investors redeem their units or ‘exit’ a scheme. Since this fee applies only to redemptions, it is also known as a back-end load. Unlike the entry load, the exit load is still very much in practice as it serves an important role – Discouraging investors from redeeming their investment before a specified period.
When investors prematurely withdraw their investment, fund managers can find it hard to maintain the fund’s portfolio effectively. They are forced to sell assets unexpectedly to meet all the redemption requests, which impacts the fund’s overall performance.
Not all mutual funds charge an exit load, and those who do, waive this fee if investors stay invested for a predetermined period. For example, an equity fund may charge a 1% exit load if investors redeem their investment before 1 year. Any redemptions after one year will not carry this 1% charge. Exit load is charged as a percentage of the net asset value when you redeem your units. This fee is calculated on the total value of the units you are selling, and it is deducted before the money is paid to you.
When is Exit Load Charged?
Whether or not an exit load is charged, and what percent, depends on the category of the mutual fund. For example,
1. Liquid funds
These types of mutual funds are known for their high liquidity, so consequently they do not charge any exit load if investors hold the units for more than 7 days.
2. Debt funds
Usually, debt funds do not charge any exit load at all, and the few who do, charge very low percentages. However, funds that follow an accrual-based investment strategy usually have higher exit loads. This is because they encourage investors to stay invested until maturity to reduce the risk from changes in interest rates.
3. Equity funds
Exit loads are most commonly found in equity funds, as equities perform best over a long period. They dissuade investors from redeeming early, which allows fund managers to invest capital more efficiently. After a certain period has passed, AMCs waive the exit load fee. This specific period is mentioned in the scheme information document.
Impact of Exit Load on Returns
Let’s take a look at an example to understand how exit load is calculated. This will help you assess its impact on your investment’s returns.
- Amount invested: Rs. 10 lakh lump sum
- Net asset value at the time of investing: Rs. 50
- Number of units purchased = 10,00,000 / 50 = 20,000 units
- NAV after holding the units for 6 months: Rs. 52
- NAV after holding the units for 2 years: Rs. 64
- Exit load: 1% if the investment is sold before 1 year.
Scenario A: Investor exits after 6 months:
- Value of investment: 20,000 * 52 = Rs. 10,40,000
- Exit load is 1% of redemption value: 1% of Rs. 10,40,000 = Rs. 10,400
- Final payout: Rs. 10,40,000 – Rs. 10,400 = Rs. 10,29,600
Scenario B: Investor exits after 2 years:
Value of investment: 20,000 * 64 = Rs. 12,80,000
Since the investment was held for over a year, there would be no exit load charged. Thus the final payout = Rs. 12,80,000
How Entry and Exit Loads Affect Mutual Fund Returns
The entry load and exit load in mutual fund investments have the potential to make a considerable impact on returns.
1. Entry Load
Before we go further into the impact of entry loads, remember that this fee was abolished and no longer applies. Let’s take our previous example:
Investment amount: Rs. 10 lakh lump sum in an equity mutual fund
Entry load: 2.5%
Net Asset Value when investing: Rs. 50.
Scenario A: AMC charges an entry load:
2.5% of Rs. 10,00,000 = Rs. 25,000 will be deducted
Total amount invested = Rs. 10,00,000 – Rs. 25,000 = Rs. 9,75,000
Number of units purchased = 9,75,000 / 50 = 19,500
Scenario B: No entry load:
Number of units purchased at NAV of Rs. 50 = 10,00,000 / 50 = 20,000
Now suppose you wish to redeem your investment after 5 years, and the NAV of the fund has increased to Rs. 75.
In Scenario A, where you have 19,500 units, your total redemption amount would be:
19,500 * 75 = Rs. 14,62,500
In Scenario B, you hold 500 extra units on account of not paying the entry load. The total redemption amount here:
20,000 * 75 = Rs. 15,00,000
You can see clearly that not having an entry load means investors can not only save more money when they initially make the investment but it also translates to higher returns the longer they stay invested.
2. Exit Load
Imagine this scenario: An individual invests Rs. 1 lakh in an equity mutual fund which charges a 1% exit load on redemptions made before 1 year. The NAV at the time of investing was Rs. 26. Due to a financial emergency, the investor had to withdraw the money prematurely after 10 months when the fund’s NAV was Rs. 28.
Number of units purchased = 1,00,000 / 26 = 3,846.15 units
Value after 10 months = 3,846.15 * 28 = Rs. 1,07,692.20
Exit load = 1% of Rs. 1,07,692.20 = Rs. 1,076.9
Final Redemption Amount: Rs. 1,07,692 – Rs. 1,077 = Rs. 1,06,615
If the investor had somehow held on for two more months, the Rs. 1,077 fee would have been avoided.
Conclusion
The entry load and exit load in mutual fund investments are two types of fees an asset management company charges investors. Entry load is charged when an investor first buys a fund’s units, and exit load is charged when they finally redeem them. Exit loads in particular are important as they discourage investors from exiting a fund early, therefore allowing the fund manager to handle the portfolio more effectively.
In an investor friendly move in 2009, SEBI abolished the entry load – A change that has improved the quality of service inventors receive from mutual fund distributors. Exit loads, however, still apply to some mutual funds, which is why it’s important to consider them before making an investment. These charges vary from fund to fund and can be avoided if investors hold their units for a pre-defined period.
