Mutual funds are a great way for beginners to start investing, but did you know that many mutual fund companies have exit loads that can eat away at your gains?
“Exit load” is a slightly misleading term. It is not the amount you lose if you exit, but the amount you lose if you exit prematurely.
It is important that as an investor you know how to reduce exit load in mutual funds because this will help you save on costs and make more money from your investments.
In this post, we will discuss how to reduce the exit load in mutual funds so you can make better investment decisions.
But first, let us understand what exit load is, why is it charged, how is it different from the expense ratio, and finally, how to get rid of it.
What is Exit Load?
Exit loads are deductions that you incur when you redeem mutual funds.
Mutual fund companies deduct the exit load from the value of your investment and then give you the balance. Most mutual funds have an exit load, but some do not.
For example, if you have a Rs 1 lakh equity mutual fund investment, and the fund company charges a one percent exit load, you will receive Rs 99,000 on redemption.
Exit Load on SIP
The concept of exit load in SIPs perplex most investors. Let me help you understand it better.
Investors believe that if they began an SIP a year ago, they will not be charged a load if they sell the investment within the time frame specified. However, many investors get it wrong.
The exit load on SIP is the same as it is for all other mutual funds. The lock-in period must be completed for each SIP installment to avoid the exit load.
For Example: If you have been investing for three years, i.e., 36months. If there is a one-year lock-in period, you will be able to redeem your SIP on the 48th month without incurring Exit Load.
Why Exit Load is Charged?
The main reason is to discourage investors from withdrawing their money frequently. Mutual funds invest in stocks and bonds of companies. The fund manager has to sell off his investment when you withdraw your money and give you the cash instead.
This can lead to higher losses for other investors in the same mutual fund. Hence, AMCs charge a small fee when you withdraw your money.
Mutual funds charge an exit load for withdrawing money from the fund before a specified lock-in period.
This is to discourage investors from exiting the fund prematurely and to ensure that the fund manager has sufficient funds at his disposal to manage the mutual fund schemes.
How is Exit Load different from Expense Ratio?
To begin with, let’s understand how mutual funds work. Mutual funds have an underlying portfolio of securities and an asset management company (AMC) that manages it.
The AMC invests your money in their in-house or affiliated schemes and generates returns out of it.
Now, these returns can be in the form of dividend payout or dividend reinvestment depending upon your choice. These AMCs charge you a fee for managing your money and this fee is known as the expense ratio.
Both Exit Load and Expense Ratio are charges levied by mutual fund houses and are a part of your scheme’s NAV (Net Asset Value). They impact your returns in different ways, however.
The exit load is a fee imposed on you if you redeem your investments within a period from the date of investment. If you don’t pay attention to the fine print, it can be a major drain on your returns.
The expense ratio is the annual cost that covers all expenses incurred by the fund house, including administrative costs, distribution costs, and remuneration for fund managers.
In contrast, unlike an exit load, which is charged at redemption, expense ratios are charged every year as long as you remain invested in a particular scheme.
Exit load ranges from Nil to a maximum of 6%, whereas Expense Ratio ratio ranges from 0.5% to 2.5%.
And finally, how to lower or get rid of Exit Loads?
If you want to save yourself the exit load, here are the practices you can follow:
1. Stay invested for long:
By holding on to the funds for a longer period, the impact of volatility and market risk gets mitigated, leading to better returns.
By staying engaged for longer, you will be able to profit from the growth potential of shares while also mitigating adverse market moves.
Most notably, Exit Loads will be eliminated.
For short-term goals, you can invest in Short-term liquid funds or Bank Deposits to get rid of Exit Loads.
2. Mutual Funds scheme without exit load:
Although some mutual funds have exit loads for all schemes, there are also some that have no exit loads for a few of their schemes.
So choose wisely!
Here is the list of some Mutual Fund schemes with No Exit Load:
- Edelweiss Diversified Growth Equity Fund,
- Quantum Long Term Equity Fund,
- TATA Contra Fund,
- DWS Alpha Equity,
- HDFC Index Sensex Plus,
- JM Nifty Plus, and
- DWS Investment Opportunity.
3. Check the time frame of your investment
If your investment horizon is long-term, then you can go ahead with any scheme.
However, if the investment is short-term, a debt fund or liquid fund is a better option because they provide more liquidity, safety, and low-risk exposure.
Examine all of the no-exit-load schemes available and pick one that best fits your investment time frame.
4. Monitor Contingent Deferred Sales Charges
The CDSC is a redemption fee or an exit load that some fund houses levy on investors who redeem their units within a stipulated period from the date of allotment.
For example, you have invested in a fund with a CDSC of 2,1,0. It means that the load will be 2% if you exit before a year, and 1% if he stays longer than a year but exits before two years. You stay with the fund for longer than two years and do not pay a load.
Hence, you can monitor the year under CDSC before redeeming your investments to lower the Exit Load.
5. Avoid frequent Switching of MF Schemes:
If you want to switch from one scheme to another within the same fund house, then you have to pay an exit load. The exit load is charged if you redeem or switch units from a scheme within a specified period, usually up to one year.
Also, there are certain instances where the exit load is waived off even if you redeem units before the completion of one year. For example, if two or more schemes from the same fund company merge, or if the plan is liquidated.
Exit loads not only protect you from selling too early but also act as a deterrent for fund managers to take higher risks because of redemption pressures.
You may think that equity mutual funds with no exit load will be better than those having an exit load. But it depends on the period for which you are investing in equity mutual funds.
Finally, I would like to say that your investments should be based on your goals and asset allocation.
Although funds without exit loads may save money, everything should not be seen from a cost-cutting perspective. Reaching your goal is the most important part of an investment.