Buying MFs: Check out the various charges

After much thought, you've taken that big step and decided to invest in mutual funds. But before you take the plunge, it's important that you take the time to research which investment is best for you.

Reading over the fund information is critical, as is the basic knowledge that the name of a fund is not always indicative of the level of safety and risk involved. Make sure the fund's objectives coincide with your own.

Do not change your objectives or exceed the amount set aside for investment without careful consideration. Request a copy of the fund's prospectus and read it carefully. This prospectus should contain a description of all fees and expenses.

Fund expenses

What are the points to consider when you evaluate a prospectus? Apart from looking at the fund's track record, latest performance and the credit worthiness of the fund managers, you need to look into the fund expenses as well.

Products with a high expense ratio do not necessarily ensure consistently positive performance.

What is the expense ratio?

This is the proportion of recurring expenses that a fund charges to its schemes year after year, and so the Expense Ratio is also known as Annual Recurring Expenses.

This basket of charges comprises the fund management fee, agent commission, registrar fees and the selling and promotion expenses. The expense ratio is disclosed every March and September and is expressed as a percentage of the fund's average weekly net assets.

A fund's expense ratio states how much you pay a fund in percentage terms to manage your money.

Different funds have different expense ratios. However, to keep things in check, the Securities & Exchange Board of India has stipulated an upper limit that a fund can charge.

The limit stands at 2.50 per cent for equity funds and 2.25 per cent for debt funds.

Let's drill it down further:

There are two types of expenses attached to a mutual fund: those that are accounted for in a fund's return, and those that are not. There are also fees that are payable to the fund company, as well as to the fund itself.

The Management Fee consists of the Performance Fee, which is based on the performance of the fund, and the Group Fee, which is calculated as a percentage of the overall assets.

The Administrative Fee is paid towards the administrative activities of the fund.

The distribution fee ranges from 0.25% to 1.0% of the fund's assets. This fee is used for marketing, advertising, and distribution services.

The brokerage cost is an expense that is not included in the expense ratio. It is shown separately in the annual report either as a percentage or as the full dollar value itself.

The interest costs, which are incurred if the fund borrows money to buy securities, are also represented in a similar way.

Expenses are not already accounted for in a fund's return are sales-related, and often referred to as Loads. The loads are compensation received by the broker for advice tendered, and is deducted at source.

These loads are of two types: front end, which is applied when the investment is made, and back end, applied when the investment is sold.

The Redemption/Transaction fee goes directly to the fund and is levied to avoid the market timers that might result in the unplanned trading of securities because of sudden inflows and outflows of cash.

An Account Maintenance fee is usually charged on small accounts.

Keep in mind that an expense ratio is charged even when the fund's returns are negative.

Before you invest in a mutual fund, it is imperative that you check out the fund's expense ratio.

What is the turnover ratio?

The turnover ratio measures the number of times that holdings are sold within a specified period of time, to determine the percentage of assets that are sold or turned over within the period of time cited.

It is also an indicator of how quickly certain current assets are converted into cash or how efficiently the assets are employed by a firm.

While the point is to look for a fund with a relatively low percentage of turnover, a high turnover ratio does not automatically mean that the fund is unstable. Shifts in the economy, for example, might have a negative impact on all stocks in that period.

Understanding the costs involved and monitoring the performance of your fund will result in an investment that is ideal for you. A good fund is one that delivers good returns with minimal expenses.