Prof. Kiran Kumar K V
Faculty – Finance, ISME
Investment planning is a complicated exercise, especially, when one is an individual investor, investing for himself. He, not only needs to learn, & understand steps like goal setting, asset allocation, security selection, adviser and agent selection and timely revision, he also needs to be aware of the cost of such process. Like in many decisions of life, even investment related decisions, should also stand the test of cost-benefit analysis. Unless the investment is expected to deliver a higher return than the cost of investing itself, the funds are better kept uninvested.
Understanding various costs, in terms of fees that an investor pays, in the process of investing, becomes a critical aspect of the decision. Even a small percentage excess fees paid by the investor, can bring down the overall maturity value of the investment in the long run. It is in this context, in this article, a summary of various fees that a retail investor may pay are discussed. The objective of this article is to create a cognizance of fees that an investor, may have to be ready to bear, in the investment process.
There are two kinds of fees – one, product or fund-level fees; two, advisory & brokerage fees by service providers. Embedded fees are generally embedded into the product cash flow projections and advisory & brokerage fees are charged over and above the embedded fees, and tend to vary from investor to investor and advisor/broker to advisor/broker.
A list of various such charges/expenses in the case of ULIPs, mutual funds and stock investing, which are three major investment options used by Indian savers, are briefly explained below:
a) Charges/Expenses in Unit-Linked Investment Plans (ULIPs):
Å Premium Allocation Charges: ULIPs charge a premium allocation charge as a percentage of premium payable. While insurance company is bound to disclose the charge, it need not mention, the purpose for which such charge is used. One can assume, this to be the sales commission/marketing expense of the product.
Å Policy Administration Charges: As the name suggests, these are charges directed by the insurance company towards, administration related expenses of the company towards the policy. These are generally, specified as certain amount of rupees per month. Some companies also, have a schedule of increasing administration charge over the years.
Å Mortality Charges: These are the actual cost of insurance coverage given by the company. For every Rs. 1000 of sum assured, depending on the age, gender, health and occupational condition, a fixed sum is prefixed, and the same is deducted from the premium paid by the policyholder.
Å Miscellaneous Charges: Most ULIPs offer flexibilities, like switching between investment fund options, partial withdrawals and various other service requests. For each such request, there may be a charge that gets deducted from the premium paid.
Å Taxes: GST is also applicable on all these charges.
Å Advisory fees are generally not charged by Insurance Agencies in this case, they are embedded as part of policy premium.
b) Charges/Expenses in Mutual Funds (MFs):
Å In the case of Mutual Funds, various charges are not transparently disclosed as in the case of ULIPs. But, every mutual fund, except ETFs, are supposed to disclose an Expense Ratio in their monthly fact sheets. These expense ratios can indicate the percentage of an investor’s invested amount, that is deducted towards the fund expenses. These expenses may include, management fees, administrative fees, operating costs and all other asset based costs. Expense ratio will not include (a) brokerage costs paid by the fund to transact the portfolio stocks and (b) sales commission paid. Note that as per SEBI, the expense ratio of an equity-oriented fund cannot be more than 2.5% of the AUM.
Å In addition to the expense ratio, an investor in a mutual fund, may also pay an exit load, if he chooses to exit before the stipulated redemption period, which is generally 6 months. The exit load can be as high as 1% of redemption value, or it may be a declining value for longer period.
Å Investor should also be aware of the Securities Transaction Tax that will be levied at 0.1% of transacted value at the time of purchase as well as redemption.
Å Advisory Fees are generally collected by the advisors in case of mutual funds. Before 2012, there used to be an entry load (of 2.25%), embedded in the NAV of the fund, that was later being distributed to the financial advisor cum agent who sourced the business, as commission. Now, the entry loads are removed, and any commission needs to be collected by the agent, on his own from the investor, and there is no limit for the same.
c) Charges/Expenses in Stock Investing:
Å At the time of opening trading account, the investor will be required to pay account opening charges. These charges are part of the administrative charges of carrying out the account opening process of the Demat and the Trading Accounts of the client.
Å During every transaction carried out, the investor will be charged a brokerage fee depending on the type of transaction. The investor will be charged approximately 0.1% on every purchase value and on every sale value, if the transaction of purchase and selling both are carried out on the same day (also, called intra-day trading). If the sell transaction happens after the day of buy transaction, (called delivery transaction), the charges for 0.5% each side. In addition to these brokerage charges
, STT at 0.1% is also charged.
, STT at 0.1% is also charged.
Å On an ongoing basis, an annual maintenance charges are also charged by the brokerage house, ranging between Rs. 500 to Rs. 1000 per annum.
An awareness of various charges also enable the investor in comparing the different investment products of different companies and service providers. Additionally, when the investor pays too heavy a charge, he may indirectly hurting his own portfolio’s return generating capacity. For instance, let’s look at an example. The below graph shows the effect of even an 1% increase or decrease in the charges, can have much larger impact on the overall terminal wealth that the investor may accumulate. (This graph is prepared assuming an investment of Rs. 50000 every year for 40 years and assuming a 7% return.)
Thus, there are two important aspects that the investor cannot ignore: (i) Different investment products have different kinds of charging expenses to the consumer. (ii) Such charges/expenses have the potential to affect the overall returns generated by the product itself.