Summary
Investing in mutual funds (MFs) is a simple way to diversify and manage your investment portfolio professionally. Load and no-load funds are two types of MF. They categorise MFs based on associated fees. Load funds impose charges for managing investments, while no-load funds usually do not. These fees affect returns and may include entry loads, exit loads, or level charges.
Investing in MFs can diversify your investment portfolio. In July 2023, the average value of assets under management in the Indian MF industry reached INR 46,27,687 crore. That's a massive sum. The sector is clearly booming.
But what are MFs exactly? How can they strengthen your investment portfolio and what are the attendant fees? Read on to learn more.
Exploring mutual funds: Understanding the basics
An MF is a professionally managed investment vehicle. It pools money from multiple investors with similar investment goals. This pool of funds is then invested in a diversified portfolio of assets, which can include equities or stocks, bonds, money market instruments, and various other securities. The main objective of an MF is to offer investors a diversified and professionally managed investment portfolio. That’s how they are designed. Regardless of whether you have a modest budget or limited expertise in managing individual assets, MFs can help you generate returns. But like most things in life, they come with associated fees and commissions. And this is where the concepts of “load” and “no-load” funds come in. They represent two categories of MFs related to their fees and can have a significant impact on your overall investment experience and income.
Load funds vs. No-load funds: The savings equation
Load and no-load funds are connected to the potential costs associated with investing in MFs. Understanding the distinctions between them is crucial, as they influence the results of your investments in MF. Let’s have a look:
- Load funds – These funds impose a sales charge. That is, they charge a fee for managing your investments. Most MFs are typically managed either by the company overseeing the fund or by a third-party investment broker or intermediary. Operating these funds involves various aspects like marketing, distribution, and ongoing management, all of which incur costs for the asset management company (AMC). As a result, when an investor decides to invest in an MF, the AMC levies a small percentage of their invested amount as the “load.”
For instance, suppose you invest INR 1,000 in a 5% load MF. In this scenario, you would effectively be investing INR 950, as the remaining INR 50 is allocated as a commission to the company. These charges are included within the expense ratio (ER) - a measurement of the portion of a fund's assets allocated to cover administrative and other operational costs of the specific fund. The load can be an:
- Entry load - A fee charged when investors initiate their investment. From August 2009, however, the Securities and Exchange Board of India (SEBI) has abolished the practice of imposing entry loads for MFs.
- Exit load - Charges imposed when an investor decides to exit the MF. It can take the form of a fixed fee or diminish gradually over a period, typically spanning from five to ten years. In the latter scenario, the percentage is at its highest in the first year and progressively declines until it eventually reaches zero.
- Level charge - An annual fee taken from an investor's MF assets to cover distribution and marketing expenses. It is also known as the 12b-1 fee and generally ranges between 0.25% to 0.75% of the fund's net asset value.
- No-load funds - No-load funds usually do not charge a fee. However, you may be required to keep your money invested for a specified period, often around five years. Investors who sell their holdings early may be subject to a fee. But those with a long-term investment horizon don’t need to worry.
Let’s simplify no-load funds with a simple example. Consider this scenario - an MF generates a total return of 10% before fees and expenses, and it has a total ER of 1%. In that case, the investor's actual return would be 9%. Now, compare this to a large-cap stock fund with an ER of 1.25 percent. If you find a no-load fund with an ER of, let's say, 0.75%, you can gain a 0.50% (1.25% - 0.75%) return advantage each year by opting for the no-load fund. Over time, this seemingly small difference can add up to substantial savings and compound interest for the investor.
When no-load funds do carry charges, they are factored into its annual ER. The management firm may cover any fees based on the fund's daily net asset value (NAV). That is, a company's total assets minus its total liabilities. The only charges that do not apply in no-load funds are the sales charges, leading to a reduction in the overall ER. To ascertain these charges accurately, it is best to consult the fund's prospectus.
Benefits of investing in load mutual funds: Exploring the rationale
While it may appear that load MFs are not the first choice for investors, there are several reasons to opt for them. For instance, they:
- Offer professional guidance: Many investors prefer having the guidance of financial advisors (FAs) to make well-informed decisions aligned with their best interests.
- Nurture relationships: Some investors have established relationships with FAs and prefer not to jeopardise these connections by managing investments independently.
- Support risk management: Brokers and FAs can also play a vital role in preventing clients from making impulsive decisions, especially during market downturns.
Unlocking savings: The no-load fund advantage
When comparing load and no-load funds, the latter often appear more appealing to investors seeking a low ER. This is because they can:
- Bring about cost savings: No-load MFs are more cost-effective since they do not entail distributors’ fees, sales charges, or additional commissions. This translates to a lower overall ER, leading to greater savings upon redemption.
- Support full amount reinvestment: In a no-load fund, the entire investment amount, including the returns, is reinvested by the fund manager. The AMC doesn't need to allocate extra funds to brokers or distributors. So, investors get to enjoy higher returns over time.
- Offer independence: No-load funds grant investors the freedom to make their own investment decisions. They do not become dependent on the guidance of brokers, agents, distributors, or managers. This autonomy enables investors to conduct their research and choose their MFs independently.
Professional advice for mutual fund investments: Making informed choices
When determining whether to invest in a load fund or a no-load fund, it's essential to emphasise that this classification should not be your sole criterion of MF selection. Instead, consider evaluating the fund's track record and stability as primary factors before making your investment decision. Seeking expert guidance can be invaluable in assessing these critical aspects. Partner with a domain expert to review, research, follow, and purchase and sell stock, including the best MF options. Based on your risk appetite, find curated portfolios for MF investments to reach your financial goals.
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