Mutual funds always have a disclaimer stating that investors must read all the documents carefully before investing in them. Yet many investors ignore it and do not pay enough attention to it. This leads to the trap of paying extra or a reduction in net profit due to various factors, like exit load as a hidden charge. These charges are levied on investment at the time of withdrawal, which may lead to a lower return than anticipated. But, is it possible to avoid it?
This article will help you understand exit load and the ways to avoid or reduce it.
Understanding Exit Load: The Hidden Charge
An exit load is a fee or charge that mutual fund companies impose when an investor leaves the scheme, i.e., redeems units within a predetermined time frame. Usually, it is stated as a percentage of the units’ Net Asset Value (NAV) that have been redeemed.
Exit loads are imposed by fund houses to reduce early withdrawals and preserve fund stability. It assists in shielding long-term investors from the financial consequences of early redemptions.
Key features:
- Represented as a percentage of the NAV (net asset value) at redemption.
- Exit loads are primarily applicable to equity and hybrid funds, while liquid funds have a graded exit load if redeemed within the first 7 days; after 7 days, there is no exit load on liquid funds.
- A typical 1% of exit load is charged for equity mutual funds.
- Impacts short-term returns by lowering the final redemption amount.
- Varies depending on the fund and is explicitly mentioned in the fact sheet or scheme document.
Impact of Exit Load on Mutual Fund Returns
Although exit load may seem insignificant at first, it can have a big impact on your total return, particularly for investors who are short-term or frequently switch between funds.
1. Decreases Effective Returns
The exit load immediately reduces your final profits if you redeem units before the designated holding period. For example, A 1% load on a ₹1,00,000 investment lowers your redemption amount by ₹1,000, which could have been included in your profit.
2. Diminishes the compounding effect
Exit loads reduce the base capital available for compounding if you are regularly redeeming and reinvesting. This may eventually result in a significant disparity in the accumulation of wealth.
3. Discriminates Against Short-Term Investing Practices
These loads gradually lower the value of your net portfolio if you switch or exit frequently without planning. Typically, long-term investors benefit as they do not take rash decisions.
4. A Hidden Expense That Impacts Net Return
Many investors take the expense ratio into account, but they neglect to account for the exit load. Exit load is a one-time expense that can drastically change your return if it is not taken into consideration in your exit strategy.
5. The Impact Varies for Different Funds
The degree of impact of exit load varies from fund to fund due to various reasons. Unintentional losses may arise from not understanding this, particularly when transferring money between categories.
6. Impact Adjusted for Taxes
Capital gains tax is calculated on the difference between the redemption NAV and the purchase NAV, without considering the exit load. The exit load is deducted from your redemption proceeds after tax calculation, and the load itself is not tax-deductible
Let’s compare two scenarios:
| Particulars | With Exit Load | Without Exit Load |
| Amount Invested | Rs. 1,50,000 | Rs. 1,50,000 |
| NAV at Redemption | Rs. 120 | Rs. 120 |
| Units Purchased | 1250 | 1250 |
| Redemption Amount (Pre-load) | Rs.1,50,000 | Rs. 1,50,000 |
| Exit Load @ 1% | Rs.1,500 | ₹0 |
| Net Amount Received | Rs. 1,48,500 | Rs. 1,50,000 |
How to Avoid or Minimize Exit Load?
- Understand the holding period: Examine the scheme’s exit load structure prior to making an investment. This is stated explicitly in each fund’s fact sheet or on the AMFI website.
- Carefully consider redemptions: Avoid early withdrawal if your objective is long-term. Await the conclusion of the exit load period.
- Select funds with low or no exit load, such as some ultra-short-term debt funds. For liquid funds, a graded exit load applies if you redeem within the first 7 days; after 7 days, there is no exit load.
- You can use Systematic Transfer Plans (STPs) to gradually move funds between schemes, but exit loads will still apply to units transferred before the exit load period ends.
Bottomline
The conclusion can be drawn that this charge is essential to prevent investors from switching funds frequently. It also encourages the short-term investor to avoid taking rash decisions to quit the fund at the time the market dips and to have patience. The importance of reading documents is important so that the investor is aware of these charges and the way to avoid them. The direct impact on net return can be huge, and hence, exercising caution is advised.
Written by: Tanya Kumari
