Know how much it costs to invest in mutual funds

5 MinsJuly 06, 2020

Mutual funds are a potent avenue for wealth creation. However, evaluating the costs involved is also necessary to earn fruitful returns. Starting from July 1, you will have to pay Stamp Duty on mutual fund purchases. This is in addition to the expense ratio, exit load and Securities Transaction Tax that already exist. Before investing in mutual funds, it is essential to be aware of these charges and how they impact your investments. Let us take a detailed look:

mutual funds

Stamp Duty – This is the latest charge for Mutual Fund transactions, introduced w.e.f July 1, 2020, which will be applicable on the issuance and transfer of mutual funds (for all categories and sub-categories) irrespective whether units are held in demat or physical mode).

Stamp Duty is a direct tax levied by the government under Section 3 of the Indian Stamp Act, 1899. The rates applicable are uniform across states so that no particular State has an advantage over others. The Stamp Duty for Mutual Funds is as follows:

Description Applicable Rate
Issue of security0.005%
Transfer of security0.015%

(Source: Notification issued by the Department of Revenue, Ministry of Finance, Government of India)

The Stamp Duty of 0.005% is applicable for purchases, fresh instalments in existing SIPs and STPs, Switch-in, and Dividend reinvestment transactions. And in case of transfer of units from one demat to another plus the off-market transfers, the Stamp Duty rate applicable is 0.015%.

The Stamp Duty will be deducted from the net investment amount, i.e. gross investment amount less any other deduction like transaction charge. Therefore, the units allotted to you will be from the balance amount, i.e. Net Investment Amount – Stamp Duty Deduction.

For units under a dividend reinvestment option, the Stamp Duty will be deducted from the dividend amount (less TDS if any) and units will be created for the balance amount.

There will be no Stamp Duty applicable at the redemption of units. However, if you frequently churn your mutual fund portfolio, the imposition of Stamp Duty may pinch you––adding to the cost of investment and lowering the return. So, avoid trading in mutual funds, approach them as an ‘investment avenue’ by planning wisely.

Expense Ratio – Asset Management Companies (AMCs) incur annual expenses towards administration, fund management, distribution and so on to run their businesses. The Expense Ratio is the percentage of average assets under management that go towards such expenses. It is also referred to as the Total Expenses Ratio (TER), which the Securities and Exchange Board of India (SEBI) has rationalised. The Expense Ratio is mentioned for each scheme.

Knowing the expense ratio of the scheme you are investing in is important to keep the cost of investing low. But it should not be the only criterion to select worthy mutual fund schemes. If the scheme under consideration has been a consistent outperformer (generated alpha), then perhaps it justifies a higher ratio. So, you need to evaluate a host of quantitative and qualitative parameters to make a prudent and suitable choice.

[Also Read: How to minimize your mutual fund losses]

Exit load – When you redeem and switch-out units of a mutual fund scheme, you may be subject to an exit load depending on how long you were invested. This is referred to as an exit penalty and charged as a percentage of the prevailing Net Asset Value (NAV) of the scheme.

This load varies across fund houses plus the categories and sub-categories of the scheme. The objective of the exit load is to discourage premature withdrawals. This is necessary for the fund management process to prevent anomalies; otherwise, the fund manager may end up selling the scheme’s assets in distress, and the existing investors may end up subsidizing for those exiting a scheme early.

An exit load could be flat or tiered (higher for shorter holding period and gradually reduce over time frames, and finally vanish beyond a certain period- days/months/years). Every mutual fund scheme communicates the exit load actively in their Scheme Information Document and other product communique. Pay attention to it if you are deciding to exit or switch out of a mutual fund scheme.

STT on mutual fund redemptions – Apart from the exit load, when you decide to sell your mutual fund units, a Securities Transaction Tax (STT) is levied. In case of close-ended schemes and ETFs, the STT is 0.001% of the traded value; 0.25% of the traded value in case of open-ended equity-oriented schemes; while no STT is levied on the sale of debt mutual fund units.

When you take investment decisions––whether to buy, hold, sell––do it in a holistic manner evaluating the scheme and your personal needs. Ultimately, the benefit has to outweigh the cost in the journey of wealth creation and accomplishing financial goals.

Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm. Axis Bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.