One of the important features that make a mutual fund an attractive investment for investors is its liquidity. Mutual funds can be bought and redeemed at any time you wish which makes it easier for you to meet your financial obligations at any time.
Though quick exits are allowed, there is a concept of exit load under many mutual fund schemes which can eat up some of the returns that you have made on your mutual fund investment
Do you understand what exit load in a mutual fund means and when is it levied on your mutual funds?
What is an exit load?
As the name suggests, an exit load is a one-time load that is applied when you exit from the mutual fund scheme. Some mutual fund schemes charge a fee when you exit from the scheme, this fee is called the exit load.
The exit load is expressed as a percentage of the Net Asset Value (NAV) and is not included in the Total Expense Ratio (TER) of the mutual fund scheme.
Why is an exit load applied?
The main reason for applying or levying an exit load is to deter you from exiting the scheme. It helps Asset Management Companies (AMCs) to retain their investors.
Moreover, when the exit load is in place, the redemption pressure on the fund manager eases up. As and when an investor places a request for redemption the Fund Manager has to arrange for cash to meet the redemption request. Having an exit load allows the fund manager to maintain the investments of the portfolio without needing to maintain high liquidity. This, in turn, increases the profitability of the mutual fund scheme, since the portfolio, which remains invested, can fetch better returns.
How is the exit load calculated?
The exit load is applied at the time of exit. It is calculated on the total redemption value of the fund. Let’s understand with an example –
Suppose you invest in a mutual fund scheme with a Net Asset Value (NAV) of INR 50. You invest INR 10,000, which earns you 200 mutual fund units. Now, the scheme has a 1% exit load applicable if you redeem within a year of investment.
Suppose you redeem 100 units after 5 months when the NAV is INR 55. Since you are redeeming within a year of investment, you would have to pay an exit load on the amount that is redeemed. So, here’s how the exit load would be calculated –
|Number of units being redeemed||100|
|NAV on redemption||INR 55|
|Exit load||1% of NAV = 1% of 55 = INR 0.55|
|Total redemption value that you get||(55 – 0.55) * 100 = INR 5445|
Exit load on different types of mutual fund schemes
Not all types of mutual fund schemes have an exit load. Some schemes allow quick redemption without any applicable load. Such schemes are, thus, highly liquid. For example, liquid mutual funds and overnight debt funds are highly liquid debt mutual funds. and do not carry any entry or exit load.
However, with many debt and equity funds, there is an exit load if you redeem the fund, wholly or partially, within a specific term, usually a year. The exit load percentages can vary between funds
So, when investing in a scheme of a mutual fund or at the time of redemption, check if there is an exit load or not. If there is an exit load, it is usually applicable for a specific period. Try to stay invested in the scheme till such period when the exit load is applicable, and then redeem. This would help you get a higher redemption value.
Exit load in case of SIPs
Systematic Investment Plans (SIPs) allow you to invest in installments so that you can invest affordably and regularly. When it comes to the concept of exit load, you need to consider each SIP investment independently.
For example, if you have made 12 SIP investments, and the mutual fund scheme charges an exit load in case of redemption within a year, each installment would be considered when calculating the exit load. In the 13th month, the first installment would have completed 12 months and would be free from any exit load. Similarly, the 14th month would allow free redemption of the 2nd installment, the 15th month for the 3rd installment, and so on.
So, to find out when the SIP would be free from exit load, calculate each installment period independently.
Where does the exit load go?
The exit load is paid to the AMC which, in turn, invests it into the portfolio itself. SEBI has directed AMCs to reinvest the exit load in the scheme portfolio. Mutual fund companies, thus, retain a part of the redemption value, which is payable as the exit load, and then pay you the net redemption proceeds. The exit load is, then, reinvested in the portfolio to give the existing investors the benefit of staying invested.
How can you avoid exit loads?
Yes, you can. If you redeem the fund after the specific period over which the load is applicable, you can avoid the exit load.
So, understand the concept of exit loads and check when the load would be applicable. Check the scheme for exit load when investing in it and try to redeem only when the exit load is no longer applicable to get better returns from your mutual fund investments.