The market regulator Securities and Exchange Board of India, SEBI, in January 2008 abolished entry load on Indian equity funds if you're investing directly. However, it is mandatory to pay an entry load of 2.25 percent if you transact through intermediaries, also known as distributors by you and me. The distributors take this charge to service investors.
How is it levied on the investor?
Investor has to be careful and aware of how this charge is levied, since nobody asks you to pay this charge separately. Instead, it is deducted upfront from your investible money right at inception.
Suppose you are investing Rs 100 and the NAV (net asset value) of the scheme that you are buying is Rs 10. This NAV is multiplied by 1.0225 (2.25 percent of Rs 10) to factor in the entry load and operative NAV for you becomes Rs 10.225 (Rs 10 as the actual NAV and Rs 0.225 as the entry load).
This takes the number of units allocated to you to 9.78 and the money invested is Rs 97.8 instead of Rs 100. The remainder Rs 2.2 (100 less 97.8) goes to the distributor and to meet other administrative expenses incurred by the mutual fund company. However, if you invest directly through that mutual fund company's website then the whole Rs 100 is invested and you hold 10 units.
Cascading effect of this cost
While you lose this money upfront, this charge literally multiplies. For example, even on a conservative basis, Indian equities can double in the 5 years. Since 2.25 percent has been deducted upfront and not been invested, what you have lost is 4.5 percent (double of 2.25 percent) from your returns.
Consequently, it is a simple decision that you should invest directly and not pay this significant charge.
New favourable development
Abolition of this load is leading to the emergence of fee-based wealth management advisories in India. Just a fraction of the money that you save through direct investment can be utilised to buy the services of such an advisory.
They will facilitate your direct transactions in addition to a host of other wealth management services.
Analysis of charges
On an average we are assuming that you are paying a rate of 0.4 percent of the assets under management (AUM) annual fee to your advisor. Since timing of cash outflows is different, we will have to take the time value of money into consideration.
Paying 2.25 percent of upfront commission is equivalent to paying 0.4 per cent of AUM every year for 13 years. In other words, what you are paying for 13 years you lose in one single shot when somebody charges you 2.25 percent upfront.
Additionally, a transaction-based company which has tasted blood by getting an upfront commission of 2.25 percent is likely to turn over your portfolio very soon and many times over, even when not required.
On the contrary, a fee-based advisor wins only when you win and his interests are totally aligned with yours. Even when he reallocates, it is at zero cost to yours and at no advantage to such an advisor and therefore it will be done only when really required.
Conclusion & recommendation
Consequently, my strong recommendation will be to take full advantage of this gift and investor-friendly move from SEBI, save lots of money and bolster your returns.
Dr Sanjiv Mehta is the MD of Finance Doctor, a wealth management company and author of the recently published book, Winning The Wealth Game: Cricket Strategies For Financial Freedom.
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