Why do Mutual Funds Charge an Exit Load?

If you’ve been investing in mutual funds for some time, you must have seen exit charges. Do you know why exit loads exist and how they can benefit you? For those new to investing, let’s start with what is an exit load in mutual funds. When you redeem your investment from a mutual fund scheme before the specified time, exit loads are charged by mutual funds as a percentage the NAV. If the scheme is not redeemed within one year, it will have a 1% exit charge. If the NAV for the scheme is INR 100, and you redeem your scheme holdings before the end of one year, you will only receive INR 99 per unit. The fund house will deduct 1% to prevent premature redemption.

The big question now is: Why should a fund house take an exit load from your money if it is your money? This is even if you invested in an open-ended plan. They said mutual funds provide great liquidity and sell it to you. This mutual funds load doesn’t contradict the entire idea that open-ended funds offer liquidity like no other investment choice. We’ll tell you why.

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All mutual funds come with an annoying disclaimer: “Mutual funds may be subject to market risk.” Before investing, please read carefully the Scheme Information Document (SID). Although it might seem annoying, this disclaimer is necessary because SEBI has required it. Before you invest, make sure you read the SID. The fund’s investment objective outlines the goals and places where your money will be invested. This will give you an indication of the fund’s indicative time horizon. The SID contains information about the fund’s indicative time horizon, risk profile and suitability. You should only invest in a fund if you agree with its investment objective, risk profile and time horizon.

A small- and mid-cap fund might have an investment objective like “The Fund seeks long-term capital appreciation through investing in small and medium-cap companies.” This implies that you must invest in this fund with at least 5-7 year horizon. The fund seeks like-minded investors who are open to taking some risk with small- and mid-cap stocks while committing to a long term investment. The fund manager wants to make sure that investors who invest in this fund are invested for a long time. To discourage investors who are looking for quick results, the fund will set an exit load.

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Investors are discouraged from withdrawing money from the fund if things are uncertain. The fund manager requires the money to manage his portfolio, and show results over a longer time horizon. However, if investors begin to redeem their units in volatile markets in the short-term this could impact the fund’s performance as the manager might have to sell good-performing stocks to satisfy the liquidity demand. These redemptions could negatively impact the holdings of existing investors. Exit loads are designed to help investors stay invested for a reasonable period of time that is beneficial to all investors. When you consider selling mutual fund units, ask yourself if you are acting out of impulse or if you really need the money.