Retail investors need to understand the costs associated with investments that will have a significant impact on returns. Higher expenses paid will reduce the amount of money invested in the plan or instrument, reduce compound benefits, and impact the overall value of the corpus in the long run.
Mutual fund expenses that are deducted from investments, direct payments such as brokerage commissions, indirect expenses such as commissions on life insurance policies, and even portfolio turnover can erode returns for investors. Avoid paying late penalties for insurance premium, systematic investment plans, public provident fund and recurring deposits.
Sushil Jain, CEO of PersonalCFO.in, says the awareness regarding capital expenditure is increasing as it has a huge impact on the corpus in the long run. “Miscellaneous capital expenditure can cost around 10% of the total corpus if you invest for 20 years,” he says.
Opt for a direct mutual fund plan, passive funds
For actively managed equity mutual funds, the Total Expense Ratio (TER) ranges between 1.5-2.25% and for debt funds it is 1.25-2%. Direct plans have a lower expense ratio than regular plans because there is no distributor/agent involved. The lower the expense rate of a plan, the higher the net asset value. Thus, the TER is an important parameter when selecting a mutual fund scheme. If someone invests through a bank registered as a distributor, they would invest in a regular plan with a higher expense ratio and not in a direct plan with a lower expense ratio. However, if the bank is a registered investment adviser, the investment could be in the direct plan.
In the direct plan, the investor will have to understand the investment strategy and select the fund themselves, do the online KYC and even opt for online redemptions. The expense ratio is deducted from its investment and the net asset value (NAV) is published. Investors can opt for passive funds if the active fund manager is unable to generate at least 2-3% additional returns compared to passive funds.
Find out before you buy life insurance
All traditional life insurance plans come with high commission costs in the early years of coverage. Most life insurers pay 60-75% of the first year’s premium and an additional 15% for each renewal as commission. The commission is paid after deduction of the premium and the rest is invested. As a result, traditional life insurance plans offer sub-optimal returns of around 5%. Even exiting a traditional life insurance policy will incur high surrender costs. For life insurance, the breadwinner should opt for a term plan that is cost-effective and can support the needs of the family in the event of an eventuality. Insurers offer discounts on online plans because they can save on commissions and other service costs.
Avoid portfolio churning
Each time an investor transforms (buys or sells) their portfolio to save tax, the overall return is impacted, as equity investments held for a longer period generate higher returns. Each time an investor shuffles the portfolio (purchase or sale), he pays a brokerage of 0.5 to 0.75% of the value of the transaction, in addition to deposit fees and transaction fees levied by the exchange. . Thus, an investor should look at net portfolio returns, rather than just tax outflows.
Brijesh Damodaran, Managing Partner, BellWether Associates LLP, explains that churning typically involves buying and selling at frequent intervals. “When you buy and sell, there may be an exit charge. In addition, with each transaction (purchase and sale), the expense ratio based on the fund’s assets under management enters into the cost of the transaction. Also, short-term or long-term capital gains can occur depending on the time horizon,” he says.
Jain says churning is not advisable at all because the cost of churning is more than the additional net return that is expected to be generated. “Costs such as exit fees, capital gains tax and loss of compounding benefits will impact long-term reinvestment,” he says.
For actively managed equity mutual funds, the Total Expense Ratio (TER) ranges between 1.5 and 2.25% and for debt funds it is between 1.25 and 2%.
Most life insurers pay 60-75% of the first year’s premium and an additional 15% for each renewal as commission
Wallet shuffling incurs brokerage fees of 0.5-0.75% of the trade value, apart from deposit fees and transaction fees levied by the exchange.