If you admit your child to a high-end school, you may think that the fees you pay are the only cost for your child’s education. But once your child starts going there, you realise that you have to pay charges for a picnic, not to a local place, but to a foreign locale. Your child’s classmates all have iPads, which they use to communicate with the teacher for projects and so you end up buying one for your child too. There will be some charges you will end up paying only to allow your child to have the best experience studying at such a place. However, these charges were not apparent when you decided to take admission. At that time, there were only fees. What you ended up paying extra, could be defined as hidden charges, charges that are not apparent on the face of it, but charges you will end up incurring. So, you are actually paying more than what you bargained for.
The concept of hidden charges in mutual funds is similar. These are charges that may not be apparent when you invest, but these are charges that end up being taken from your funds and therefore they will actually reduce your overall returns. Here is a guide to some of the hidden charges that you may pay as an investor.
Expense Ratio/Management Fees
Usually, you invest in mutual funds through an asset management company. This asset management company will charge a fee to manage your portfolio. This is called the expense ratio or management fee. The expense ratio usually ranges from nothing to 2.5%. This charge is deducted from your returns. Hence, with a 1% expense ratio, if your fund has a return of 5%, effectively you are only getting a 4% benefit. The expense ratio is calculated as a percentage of the total expense incurred on a fund divided by the total asset value of the fund. This is known as the Total Expense Ratio.
Entry and Exit Load
These are charges to be paid usually at the time of buying and redeeming your mutual funds. The entry load as the name suggests is a charge imposed for buying the mutual fund, it is like a commission. Not all funds have an entry load. Similarly, the exit load in a mutual fund refers to charges imposed while exiting or redeeming the fund. The exit load is usually kept as a deterrent so that investors do not get in and out of funds frequently. In the case of an exit load, the fund management company puts in a lock-in period. If the investor sells the fund before the lock-in period ends, then he is charged the exit load. The exit loads range between 0.25-4% usually.
Account Fee in Mutual Funds
This is a charge made by some mutual fund companies in case an investor doesn’t maintain a minimum balance. When the fund amount goes below the minimum balance amount, then the asset management company deducts a particular amount from the returns.
Switch Price in Mutual Funds
This is the price to be paid to the asset management company while switching between mutual fund plans of one scheme to the other.
Following is a table on the website of the Association of Mutual Funds in India giving details of the norms set out by SEBI on the Total Expense Ratio.
| Assets Under Management (AUM) | Maximum TER as a percentage of daily net assets | |
| TER for Equity funds | TER for Debt funds | |
| On the first Rs. 500 crores | 2.25% | 2.00% |
| On the next Rs. 250 crores | 2.00% | 1.75% |
| On the next Rs. 1,250 crores | 1.75% | 1.50% |
| On the next Rs. 3,000 crores | 1.60% | 1.35% |
| On the next Rs. 5,000 crores | 1.50% | 1.25% |
| On the next Rs. 40,000 crores | Total expense ratio reduction of 0.05% for every increase of Rs.5,000 crores of daily net assets or part thereof. | Total expense ratio reduction of 0.05% for every increase of Rs.5,000 crores of daily net assets or part thereof. |
| Above Rs. 50,000 crores | 1.05% | 0.80% |
Thus, knowing the expense ratio and such hidden charges is very important for making sound investment decisions, as it will give a complete idea of what the actual return from the investment would be.