Mutual fund schemes are quite liquid. Except for ELSS funds which have a lock-in period of 3 yrs or closed-ended funds which generally have a maturity of around 3-5 yrs, other schemes allow you to enter or exit from them anytime that you want to. However, under some schemes, there is an exit load applicable when you redeem or switch your units.
This article covers:
What is exit load in a mutual fund?
The word ‘load’ means a charge or a fee and the word ‘exit’ means to leave. Combine these two words and the meaning of exit load becomes quite explicit. The exit load is a charge levied when you exit from the mutual fund scheme, partially or fully. Usually, mutual fund schemes charge an exit load on an early exit, i.e. exit from the fund within a specified time. If you stay invested for the stipulated period, it may be possible to escape the exit load.
Features of exit load in mutual fund
Here are some of the most common aspects of the exit load in a mutual fund scheme:
- The load is expressed in the form of a percentage, i.e. maximum 7% of the exit value.
- The rate of exit load and the conditions of its application are stated in the Scheme Information Document.
- The load is applied on the redemption proceeds, i.e. the amount that you receive when you redeem your mutual fund units.
- The Asset Management Company (AMC) deducts the exit load before crediting the redemption proceeds to your account.
- Not all mutual fund schemes have an exit load. Some schemes allow free exits.
- Short-term debt funds, like liquid funds and overnight funds, do not, usually, apply any exit load. However, in a recent directive issued by, liquid mutual funds would charge a staggered exit load if you exit within the first 7 days of investment.
- Usually, the exit load is higher in equity mutual funds as well as in actively managed mutual fund schemes.
Calculation of exit load in mutual fund
As mentioned earlier, the exit load is levied when you exit from a mutual fund scheme. Here’s how it is calculated –
Amount of exit load = Redemption proceeds x exit load rate
The charge is deducted from the redemption amount and paid to the investor.
For example, say a mutual fund scheme levies an exit load of 2% if you exit within a year of investment. You invested Rs 1 lakh in the scheme which had a NAV of Rs 20 thereby getting 5,000 units. You invested in the scheme in Jun 2021.
Now, in Dec 2021, you decide to exit from the scheme when the NAV is Rs 25. Since you are exiting within a year, the exit load would apply. It would be calculated as follows:
|NAV as on the date of exit||Rs 25|
|Number of units||5,000|
|Amount of exit load||25 x 5,000 x 2% = Rs 2500|
|Redemption value receivable||(25 x 5,000) – 2500 = Rs 1,22,500|
If, however, you choose the SIP mode of investing in mutual fund schemes, the duration of each instalment would be considered when calculating the exit load.
For example, say you invest Rs 10,000 every month in a mutual fund scheme through SIP. An exit load of 2% is applicable if you exit within 12 mth of investment. You start your investment on 1st Jan 2021 when the NAV is Rs 10. You get 1,000 units. Thereafter, on 31st Dec 2021, you redeem 2,000 units when the NAV is Rs 16.
In this case, the first 1,000 units that you bought on 1st Jan would not attract any exit load since they complete 12 mth on 31st Dec 2021. However, the remaining 1,000 units would have been bought in consecutive months. As such, they did not complete 12 mth and would attract an exit load. The amount would be calculated as follows:
Exit load payable = 1000 (redeemed units on which exit load is applicable) x Rs 16 (NAV on redemption) x 2% = Rs 320
So, you would get Rs (32,000 – 320), i.e. Rs 31,680 on redemption.
Why is exit load levied?
Exit load is levied by the Asset Management Company to discourage or demotivate investors to exit from the scheme within a short period. It provides security to the fund manager to manage the fund with more room for asset allocation when investors tend to stay invested for a longer duration. The fund manager can invest in securities that have a good long-term profit potential for maximum returns when the threat of early exits does not impede fund management decisions.
In funds where there is no exit load, fund managers know that investors can redeem their investments anytime. As such, they try and maintain sufficient liquidity in the portfolio to meet the redemption pressure. This might impact the return-generating potential of the portfolio. On the contrary, if funds have an exit load, the fund manager knows that the redemption pressure might be limited. As such, they can restrict the proportion of liquidity in the portfolio and use the funds to invest in return-yielding securities. This, thus, has a positive effect on the returns of the scheme as well.
When investing in a scheme, understand what is exit load in a mutual fund to know the charges associated with the scheme. Check out the exit load under different schemes and opt for one that has a low exit load or a rate you are comfortable with. Also, if you have a short-term investment horizon, a scheme without any exit load would be a better alternative.
So, do your research when investing in mutual fund schemes so that you can maximize the returns that you may earn from them.