A mutual fund is a separate entity that pools investment funds from various interested parties and invests them into a diversified set of assets. This pool of investment is professionally managed by the fund manager so that you don’t have to worry about reconstituting your portfolio in case of market changes.
Mutual funds charge specific fees for managing your investments as a company. This charge is referred to as a load.
When mutual fund charges would be levied would depend on when the AMCs assess the fees.
What Is An Exit Load In A Mutual Fund?
An exit load is a penalty charged to the investor at the time of retrieving or exiting an investment. The primary aim of levying an exit load is to discourage investors from retrieving their funds from an investment before the lock-in period.
A mutual fund manager determines an average investment term suitable for your risk tolerance based on the return you wish to receive. Thus, if you withdraw your funds before that, the equation of risk-return changes for other existing investors. In order to be fair to the existing investors, the fund charges an exit load as a penalty.
An exit load is imposed on investors to keep them from withdrawing their funds during the specified lock-in period.
However, it is crucial to remember that only some schemes have an exit load applicable to them. Thus, you should read through your scheme documents carefully before investing.
How is Exit Load Calculated?
The exit fee in a mutual fund is charged as a percentage of the Net Asset Value (NAV) at the time of redemption of the mutual fund units. NAV is the net value of all assets minus the liabilities of the company.
The exit load is reduced from the NAV before crediting the proceeds to the investors. The fund managers usually decide the percentage at which exit load must be deducted.
Let us illustrate this with an example:
Assume Mr. A has invested INR 8,000 in a mutual fund scheme B in Nov ’21. The NAV of the scheme is INR 100 and the exit load on redemptions within one year is 1%.
Additionally, in Jan ’22, Mr A invested INR 5,000 in the same fund with a NAV of INR 100.
How will you calculate the exit fee for redeeming the fund in Sep ’22, when the NAV is INR 120?
What is the exit fee for redemption in Dec ’22 when the NAV is INR 125?
Step 1: Calculate the units purchased
| Number of Units bought in Nov’21 | Rs. 8,000/100 = 80 (Total NAV/Number of Units bought) |
| Number of units bought in Jan’22 | Rs. 5000/100 = 50 |
For redemption in Sep ’22, the exit load would be charged for both investments in Nov ’21 and Jan ’22 as per the prevailing NAV of INR 120 in September.
| Exit Load | 1% of [(80 +50) x 120] = Rs 156. |
| The amount credited to the investor | 15600 – 156 = 15444 (Total NAV – Exit fee) |
Step 2: Determine exit load and final distribution to the investor
In case of redemption in Dec ’22, the first investment of Nov ’21 crosses the lock-in period of 1 year. It, therefore, does not incur an exit load upon redemption.
However, the second investment in Jan ’22 will incur an exit charge of 1%, as indicated below.
| Exit Load | 1% of [50 x 120] = Rs 60. |
| The amount credited to the investor | 6000 – 60 = 5940 (Total NAV – Exit fee) |
How is Exit Load Calculated on Lump Sum Investments?
If you’ve invested a lump sum amount in a mutual fund, here’s how you can calculate the exit load.
Assume you’ve invested ₹50,000 in a mutual fund scheme. The applicable exit load if you redeem the fund 12 months before the expiration date of investment is 1%. After about 6 months, the fund value rises to ₹60,000, which prompts you to redeem your investment.
Since you’re redeeming the fund before 12 months, an exit load of ₹600 (₹60,000 x 1%) will be deducted, and the remaining ₹59,400 (₹60,000 – ₹600) will be credited to your account.
Exit Loads On Different Types Of Mutual Funds
Exit loads are fees charged by mutual funds when investors redeem or withdraw their investments before a specified period. The amount of exit load varies based on the type of mutual fund. Here is an explanation of exit loads on different types of mutual funds:
Equity Funds
Equity funds generally have higher exit loads compared to debt funds. This is because equity funds are designed for long-term investment tenures, and exit loads discourage frequent redemptions. Most actively managed equity funds charge exit loads, which means investors need to pay a fee when they redeem their investments before a certain period.
However, it’s important to note that many index funds do not charge any exit loads, providing an option for investors who want to avoid these fees. Alternatively, investors can consider investing in Exchange Traded Funds (ETFs), which typically do not impose exit loads. It is crucial to understand that equity funds are suitable for long-term investments, and investors should align their investment strategy accordingly.
Debt Funds
Debt funds generally have lower exit loads compared to equity funds. However, certain debt funds, such as overnight funds and most ultra-short duration funds, do not charge any exit loads. These funds are designed for short-term investment horizons, and investors can redeem their investments without incurring any exit load fees. In addition to overnight and ultra-short duration funds, many schemes within specific types of debt funds, such as Banking and PSU funds and Gilt funds, also do not charge any exit loads.
On the other hand, debt funds that follow an accrual-based investment strategy, which involves holding securities until maturity, tend to charge higher exit loads. The higher exit loads in these funds aim to encourage investors to remain invested until the securities mature, reducing the risk associated with changes in interest rates.
Hybrid Funds
Hybrid funds, including arbitrage funds, impose exit loads for early redemptions. These funds invest in a mix of equity and debt instruments and are suitable for investors seeking a balanced approach. Many investors mistakenly believe that arbitrage funds, similar to overnight funds, have no exit loads and are meant for very short durations. However, the reality is that most arbitrage funds do charge exit loads for redemptions made within a specific period, usually between 15 to 30 days. Therefore, investors interested in arbitrage funds should have an investment tenure of at least one month or longer to avoid incurring exit load fees.
Conclusion
The purpose of mutual fund exit loads, where applicable, is to discourage early redemptions in order to protect investors’ interests. When investing in a mutual fund, you should always check the mutual fund exit load or mutual fund fees.
Exit load periods are not always one year as commonly assumed. If you read the information documents, you will be able to understand exit loads, which will help you make wise decisions.
FAQs
What is an exit load in mutual funds?
An exit load is a fee charged by mutual funds when investors redeem or exit their investment before a specified period. It is essentially a penalty imposed on early withdrawals.
Why do mutual funds charge exit loads?
Exit load on mutual funds is charged to encourage long-term investment behaviour and deter investors from making hasty decisions that may negatively impact the fund’s performance.
How is the exit load on mutual funds calculated?
The calculation of exit loads varies across mutual fund schemes. Typically, exit loads are expressed as a percentage of the redemption amount or the Net Asset Value (NAV) of the units being redeemed. The exact percentage and the holding period required to avoid the exit load will be mentioned in the scheme’s offer document or Key Information Memorandum (KIM).
Do all mutual funds charge exit loads?
No, not all mutual funds charge exit loads. It depends on the specific scheme and the type of fund. Equity funds, hybrid funds, and some debt funds commonly impose exit loads, but there are exceptions. For instance, index funds and certain debt funds like overnight funds and ultra-short duration funds often do not charge exit loads.
How can I avoid paying exit loads on mutual funds?
To avoid paying exit loads on mutual funds, investors should adhere to the minimum holding period specified by the mutual fund scheme. If you plan to redeem your investment before the completion of the specified period, you will likely be subject to the exit load. Therefore, it’s important to carefully consider your investment tenure and choose funds with exit load policies that align with your investment goals.
Does exit load reduce NAV?
No. The exit load is levied on the redemption amount and doesn’t affect the Net Asset Value of the mutual fund.
What is the difference between exit load and expense ratio?
The exit load is a fee that’s levied for redeeming the fund before the expiry of the specified holding period. The expense ratio, meanwhile, is the fee that’s levied for managing and operating a mutual fund scheme.
What is a good exit load?
The lower the exit load, the better. Most investors often consider an exit load of 1% or lower to be good. In fact, there are a few mutual fund schemes that don’t levy any exit load.
