How your early exit from a mutual fund scheme benefits other investors

Many investors start a SIP or make a lump sum investment in a mutual fund scheme without giving it much thought. When they realise the fund is not aligned with their goals or is not generating the desired returns, they make an early exit from it.

However, an early exit from a mutual fund can lead to a charge in the form of an exit load, which is an add on expense for the redeeming investor but beneficial for those staying invested in the fund. in this article, let's understand how this works.

Exit load is basically a fee that investors have to pay to the AMC on redeeming their units before a pre-defined period. However, the AMC is required to reinvest the amount collected by way of exit load in the fund.

The exit load paid by investors does not become a source of profit for the fund house. Instead, it is reinvested in the fund. This helps offset the impact of early redemption by investors on the fund's portfolio assets. It also helps compensate existing investors who choose to remain in the fund for a longer term.

What SEBI rules say

As per Securities and Exchange Board of India (Mutual Funds) (Second Amendment) Regulations, 2012, exit load charged by a fund has to be credited to the scheme. This regulation came into force from October 2012.

Even SEBI's Master Circular on Mutual Funds, released in 2024, mentions this provision, stating, "The exit load charged, if any, after the commencement of SEBI (Mutual Funds) (Second Amendment) Regulations, 2012, shall be credited to the scheme."

So, when you make an early redemption before the predefined period, you pay a charge, but the existing investors of the scheme benefit, as the amount paid by you gets reinvested in the scheme.

Why is exit load imposed?

While most open-ended mutual fund schemes offer full freedom to redeem at any time, a few schemes impose an exit load on early redemption. The exit load structure is specified in the scheme information document (SID) and the fund's factsheet.

The exit load amount is set as a fixed percentage of the applicable NAV at the time of redemption.

The following are some examples to help you understand more about exit load:

Suppose a scheme has specified an exit load of 1% if redeemed within 1 year. If you invest in this fund today and redeem before the completion of 12 months, then you will have to pay a penalty of 1% on the applicable NAV. So, if the NAV on the day of your early exit is ₹300 per unit, then ₹3 per unit would be charged as exit load and ₹297 per unit would be returned to you.

Suppose you invest ₹1,00,000 in a fund with a NAV of ₹100 today, knowing that this fund has an exit load of 1% if redeemed within a year. With this amount, you will get 1000 units of the fund.

However, after 11 months, you are not happy with the performance of the fund and decide to redeem when its NAV is ₹105. Your portfolio's total value at that point is ₹105*1000 = ₹1,05,000.

In this case, you pay an exit load of ₹1.05 per unit. Total exit load will be ₹1.05*1000 = ₹1050.

Thus, the amount that you will get on early redemption will be ₹1,05,000-₹1050 = ₹1,03,950.

Moreover, the ₹3950 gain will be treated as a short-term capital gain and taxed at 20%.

However, if you wait for 12 months, you won't pay the exit load. Moreover, your gains will be treated as long-term capital gains, which are tax-free up to ₹1.25 lakh.

Benefits of exit load

• Discourages short-term trading in mutual funds

• Ensures investors remain committed to the fund for the intended investment duration

• Gives freedom to the fund managers to invest the pooled funds effectively, without worrying for large-scale early redemption.

• Helps the fund managers in maintaining a stable pool of assets.

Different funds have different exit load structures. For instance, an equity mutual fund can have 1% exit load on redemption before one year, while debt funds may have shorter or no such restrictions. Some passive funds also have zero exit load these days.