Charges in Mutual Funds: Different Types & SEBI Guidelines

India’s mutual fund industry saw its collective assets under management spiralling some 78% over five years from February 2018 to February 2023, with the push coming from SIP inflows that rose 53% over this period.The data points to immense popularity that retail mutual funds enjoy among Indian investors, and part of is because mutual fund investment options are so varied.But as investors flock to the various mutual funds, it is also imperative they have a clear idea of the various charges in mutual funds. It helps in get a clear idea of their expected returns. Also Read: What Are Mutual Funds? How Do They Work & How to Invest?

Keeping track of the economy and the various industries and managing mutual fund schemes to get the best out of the conditions require experts and advanced tools; these cost money.In view of this, market regulator SEBI has allowed the Asset Management Companies to levy charge their investors for managing the various funds.These mutual fund charges include advisory fee, fund managers fee, legal fee, operational costs, audit fees, registrar and transfer agent fee, investment management fee, distribution fees, and marketing fees.All expenses charged by the mutual fund house are together called the Total Expense Ratio (TER).

The expense ratio is the amount of money an investor must pay the AMC as fees for maintaining and managing their mutual fund.The expense ratio is based on the daily investment value and is an unavoidable charge in mutual funds. Consequently, it is not the same for all mutual fund schemes.The expense ratio is calculated on a percentage basis. For example, if an investor invests Rs. 50,000 in a mutual fund with a hypothetical expense ratio of 2%. Then the investor will have to pay Rs. 1,000 as the charges for maintaining the mutual fund scheme to the AMC.Please note, lesser the expense ratio, higher the returns the investor earns. An investor, therefore, needs to see the expense ratio of the mutual fund scheme before investing in it. Also Read: Mutual Fund Expense Ratio: What is it, its Calculation & Formula

The expense ratio is calculated using the formula: Expense ratio = total cost borne by the mutual fund / average assets under management x 100.So, for a mutual fund scheme with an AUM of Rs. 900 crore and expenses of Rs. 18 crores, the expense ratio will work out to: 18 crore / 900 crore x 100 = 2 %.This means the investor must pay the AMC 2% as expense ratio or mutual fund charges.This is deducted daily until the investors redeem the mutual fund scheme units. An example of how it works daily:Supposing the expense ratio of a mutual fund scheme is 1.50%, and the investors’ investment in this fund is Rs 1.5 lakhs. Let us assume the fund's value grows to Rs 1,50,750 the next day and Rs. 1,50,500 the day after. Thus, the investor pays these expense ratios the following two days:Day 1: 1.5% / 365 x 1,50,750 = Rs. 6.19.Day 2: 1.5% /365 x 1.50,500 = Rs. 6.18.This portion is paid to the Asset Management Company daily as mutual fund charges. These daily expenses reduce the returns of the investor. This must be paid irrespective of whether the mutual fund scheme gives profitable returns or not.

Mutual funds charges are of two types: One-time charge, and recurring charge. These charges have many variations to them. Let us take a closer look.

1. One-time mutual fund charge

A one-time mutual fund charge also called the entry load has now been scrapped following a SEBI order. Charged only once – at the initiation of the mutual fund investment – it was 2.25% of the total value of the investment.But another one-time mutual fund charge exists: the exit load. This is a commission charged to the investor for exiting or selling the mutual fund scheme units before the stipulated period. This commission differs with mutual fund schemes and is usually between 0.25% and 4%. The exit load is designed to keep investors stay invested in the mutual fund until its maturity.A type of exit load is the CDSC (Contingent Deferred Sales Charge). The longer an investor stays invested in the mutual fund scheme, the lower is the CDSC is.Redemption charges are levied if fund units are redeemed; earlier the redemption, more is the amount charged under this head. There is no redemption charge if the investor continues with the mutual fund investment until maturity.

2. Recurring mutual fund charges

A recurring deposit is a periodic fee which is charged either monthly, annually or quarterly. This fee is charged for maintaining the investor's portfolio, marketing, advising, administration, and other expenses. These mutual fund charges can be distinguished in the following way:

• Distribution and service fee An AMC needs resources for promotional purposes to reach out to potential investors for its new schemes as well as for their existing ones. Such promotional expenses include expenses incurred on marketing, printing, advertising and sending mail to existing customers etc. These costs are passed on to investors.
• Management fee Fund managers are assisted by experts who include market analysts, financial advisors and other experts in this field. The AMC charges mutual fund investors a fee from for the services rendered by these professionals. This fee does not come under any other expense.
• Account fee Investors are required to keep a minimum balance in their trading accounts. This is considered an account fee. If the minimum balance is not maintained, AMC deducts it from the investor's portfolio.
• Switch price Investors may want to shift their invested amount from one mutual fund scheme to another. This attracts a fee called the switch price.

Mutual fund schemes offer two plans: regular plans and direct plans , and their charges differ.In the direct plan, you buy the mutual fund directly from the AMC. This is considered more cost-effective because no extra commission to a middleman are required.Whereas, the regular plan consists of buying the mutual fund through a middleman, like a financial advisor. If you are not familiar with the market and need guidance, this can be helpful. However, it comes with a drawback - you have to pay a commission to the middleman, which increases the overall cost of the investment. Regular plans offer some conveniences, like quick and one-time KYC process, but they are generally more expensive due to the commission fees.The difference in TER between regular and direct plans ranges from 0.5% to 1%. This means the CAGR (Compound Annual Growth Rate) return is higher for direct plans, which also leads to higher profits for them.The NAV of funds under direct plans is more than that of those under regular plans. This means units of a mutual funds in regular plans are available at a lower price.Do note that it is the value of the assets of regular plan that is lower, and not necessarily its price. Also read: Understanding NAV for Mutual Funds

SEBI guidelines on mutual fund charges were amended in 2012. One change that affected the expense ratio was the basis point (bps), expressed in percentage and is 1/100th of 1%.SEBI has issued a mandatory TER limit for equity and debt funds. These mandatory limits are:

Investors in mutual funds are advised to consider mutual fund charges as these impact returns. Furthermore, it can also help the investor get a better picture of the expected profits.