No entry load for mutual funds (MFs) – How SEBIs move positively impacts you

In a welcome move, SEBI has totally abolished the entry load charged by mutual funds (MFs) effective August 1, 2009. Read on to know how this impacts you.

This applies to all MF units purchased after 1st August, and in any form:

• Purchase of units in an existing MF scheme where you don’t hold any units already
• Purchase of units in an existing MF scheme where you already hold some units
• Switch over from one MF scheme to another
• New MF schemes (New Fund Offer or NFO)
• Systematic Investment Plans (SIP)

(NFOs might not always be good for you. Check out “When at-par is not so good: New Fund Offer (NFO) versus existing schemes” for more)

So, why is this so great for you? Read on.

Impact of entry load

Entry load is an upfront charge levied by fund houses when you invest in various MF schemes. This load used to vary from 0% to 2.5%.

This load was charged (supposedly) to compensate the MF houses for marketing and distribution costs.

The charging of entry load resulted in less of your money being invested in an MF scheme.

Let’s say you invest Rs. 5,000 every month in an MF scheme. If there is an entry load of 2%, Rs. 100 would be deducted upfront from your investment.

That is, instead of the full Rs. 5,000, only Rs. 4,900 is actually invested in the fund. (You think such a small amount wouldn’t matter? Absolutely wrong – read further for some eye opening facts!)

Positive result of this move

So, why is the removal of entry load such a great move? How does it impact you?

Higher returns for the same investment

If you are a regular and long term investor in equities (which you should be – check out “Stocks – The winning bet for the long term” and “Systematic Investment Plan (SIP) – A rupee a day, keeps worries away”), this move gives you tremendous benefits.

Let’s understand this using an example.

You invest Rs. 5,000 every month in an MF scheme. If there is an entry load of 2%, only Rs. 4,900 would be invested in the fund. If there is no entry load, Rs. 5,000 would be invested for you.

Let’s also assume that you continue this SIP for 5 years. You get an average return of 15%.

Your total investment over 5 years would be Rs. 3,00,000. What would you get at the end of the 5 years in each case?

When an entry load of 2% is charged, your investment grows to Rs. 9,25,980 at the end of 5 years. When no entry load is charged, the same investment grows to Rs. 9,44,878.

(Please download the spreadsheet to see the full calculations. You can change the figures and see exactly how much would you benefit)

(You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)

That is a difference of Rs. 18,898. On your investment of Rs. 3,00,000, this turns out to be about 6.3%.

And remember – this 6.3% extra is totally free! You don’t have to do anything extra for this. You used to pay this to the fund house – now, you would get it!

(As the regular readers would have correctly guessed, the reason for such a small amount making a big difference is compounding – check out “Start saving early and gain from Compounding – Early bird gets the worm” for more on it)

Lesser advice to churn your portfolio

From time to time, most MF agents (many guised as “investment advisors”) ask you to sell a particular fund that you hold, and ask you to purchase something else instead. The reason stated is: the fund you are holding is “underperforming”, and the other fund can give you better returns.

This might be true some times, but many times, you get this advice because when you buy a new fund, the MF agent gets a fresh commission! Yes, from your entry load!

Now that there is no entry load, hopefully, these mutual fund agents would not ask you to churn your portfolio frequently. This means more peace of mind for you, and a more stable portfolio that is based totally on your needs.

Improvement in quality of service due to fee-based advisory services

Now that MF agents and the so called “advisors” would not get any commission from fund houses for the sale of their units, most such people would start offering fee based services.

This means that for advising you about what to buy, what to keep and what to sell, they would charge a fee – it can be a fixed monthly / yearly fee, or a fee based on the quantum of your investment.

In any case, they would get paid directly by you. This means much better service for you.

Why? Because now, you would have quite a bit of control. If you think that the advice you are getting is not good enough, you can go to someone else! And these agents and “advisors” would know this. And therefore, they would act in your interest!

(Note: I too offer a fee based financial planning service. Please check out “My Financial Plan” for more)

Lesser New Fund Offers (NFOs)

Fund houses routinely launched NFOs which were very similar to existing schemes. And MF agents recommended them, as they got handsome commissions from the entry loads.

This would stop, as the incentive due to “entry load” goes away. Instead, an NFO would be launched only when there is a genuine need for the new scheme.

Change in the attitude of investors

We saw the many advantages of the abolishment of the entry load.

However, to benefit fully from such moves, it is important for you to understand that a genuine advisor plays an important role in the performance of your portfolio. And that such a useful service can not be free.

Till now, we have been used to getting advice “free”. But remember, it wasn’t really free because the advisors were paid from your entry load – even when he recommended something that was not good for you!

Now, you would get to invest the full amount, but you need to pay a fee to the advisor. And I bet that a good advisor would generate lot more returns for you than the fee he charges. Not to forget that he would now have your best interest in mind when he suggests an MF scheme for investment.

So, please get used to paying for the investment advisory service that you get – just like you pay for the service of a doctor or a lawyer!

Beware of the Unit Linked Insurance Plan (ULIP)

What does a ULIP have to do with abolishment of entry load on MFs?

Now that MF agents and investment advisors don’t have to gain anything directly form selling you MFs, some might start pushing ULIPs, where they get huge commissions by selling them.

And some might try to sell you ULIPs even when you don’t need them!

(For more on ULIPs, please check out “ULIP v/s Endowment Plan for Life Insurance” and “Are ULIPs a costly form of term insurance plus MF investments“)

So, be careful and choose a right advisor – someone who understands your needs, and recommends only the investment product that is best for you.

Other articles you might be interested in:

• Budget 2009-2010: Personal income tax (IT) related changes and impact on you
• RaagVamdatt.com launches financial planning service in India – “My Financial Plan”
• Taxation Regimes – EEE EET ETE TEE – What do these mean?
• RaagVamdatt.com – Redesigned, upgraded and relaunched
• ICICI Bank cuts lending rates (FRR and I-BAR)
• Birth of a child – how should your financial planning change?
• Understanding the components of your salary and their taxation
• Defined contribution and defined benefit pension schemes / plans
• Understanding Deep Discount Bonds
• How to use a credit card – the financially prudent way
• Health is wealth – Everything you should know about buying Health insurance
• Indian banks cut deposit and lending rates – yet again
• SBI offers discounts for “Green” home loans

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