Considering Redeeming Your Mutual Funds? Here’s Why You Shouldn’t Overlook Exit Load

Jan 08, 2025 / Reading Time: Approx. 10 mins

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In 2024, the Indian equity market experienced significant turbulence, primarily influenced by escalating geopolitical tensions, inflationary concerns, and uncertainties in the global economy.

As we step into 2025, many of these headwinds are likely to persist. In a volatile environment, it is natural for investors to feel uncertain about the future of their mutual fund investments and consider redeeming or selling them. However, while selling is an integral aspect of managing investments, the decision should not be an impulsive reaction to market volatility.

Beyond its potential implications on long-term financial goals, redeeming mutual funds prematurely involves costs and tax implications that must be carefully considered. One such cost is the exit load, a fee that can significantly affect the final returns on investment.

In this article, we will break down the basics of the exit load in mutual fund investments, how it is calculated, and discuss its potential impact on your net returns.

What Is Exit Load in Mutual Funds?

Exit load is a fee charged by mutual fund houses when an investor redeems their units or switches from one fund to another within a specified period after purchasing the units.

It is calculated as a percentage of the Net Asset Value (NAV) applicable at the time of redemption.

The exit load structure typically revolves around two key parameters:

  • The stipulated time period from the date of purchase, and

  • The rate or percentage that is applied to the NAV

It's important to note that the exit load is not standardised - it differs across fund houses and schemes.

Details about the exit load are provided in the Scheme Information Document (SID) of each fund, helping investors understand the conditions before investing. Additionally, as per the guidelines from the Central Board of Indirect Taxes and Customs (CBIC), mutual fund houses are liable to pay a Goods and Services Tax (GST) of 18% on the exit load collected.

Essentially, exit load is akin to a penalty for early exits and is intended to deter investors from withdrawing prematurely and encourage staying invested for a minimum period.

[Read: How to Read a Mutual Fund Factsheet: Key Metrics You Need to Know]

This approach not only reduces the frequency of withdrawals but also enables the fund manager to manage the fund more effectively. Many mutual fund schemes, particularly equity-oriented ones, are structured with a long-term investment horizon in mind.

Therefore, frequent withdrawals by investors can disrupt the fund's operations and negatively impact its overall performance. Exit load also serves to protect the interest of those investors who opt to maintain their investments.

How Is Exit Load Calculated?

The exit load is charged on the NAV at the time of redemption. Suppose a mutual fund scheme has an exit load of 1% on redemptions made within the first 365 days (the stipulated time period).

If you decide to redeem 100 units and the NAV at that time is Rs 1,000, you will receive Rs 990 per unit after deducting the exit load [Rs 1,000 - Rs 10 (1% of 1,000)]. For 100 units, the total amount you will receive is Rs 99,000 (subject to the Securities Transaction Tax, as applicable).

In the case of Systematic Investment Plans (SIPs), the calculation becomes a bit more complex. For every instalment, the individual holding period is taken into consideration when calculating the exit load.

The first-in-first-out (FIFO) principle is applied here. This means that when you redeem units, the earliest SIP instalment is considered redeemed first. If that instalment hasn't completed the stipulated time period, an exit load will apply. For instalments that have passed the time period, no exit load is charged.

 

The Impact of Exit Load on Returns

As you can see from the above calculation, exit loads directly affect your mutual fund returns.

While the fee might seem minor, its cumulative impact can be significant, especially for large investments or frequent redemptions. Therefore, it is crucial to ensure that the exit load structure aligns with your financial objectives before opting for mutual fund redemption.

Is it Possible to Avoid Exit Load?

Exit load is primarily charged to discourage investors from withdrawing their funds prematurely. Thus, it is possible to avoid this fee by staying invested for the duration specified in the mutual fund scheme.

The stipulated time period is clearly outlined in the Scheme Information Document (SID). For instance, if the exit load applies to redemptions within 365 days, waiting until the 366th day to redeem your units ensures you won't incur this charge.

For investors seeking flexibility and liquidity, the type of mutual fund chosen plays a significant role in determining the exit load.

You see, equity mutual funds generally come with higher exit loads compared to debt funds because they are designed for long-term investment horizons (typically 3 years or more).

[Read: Redemption of Mutual Funds: Here's How to Go About]

Equity-oriented Exchange Traded Funds (ETFs) or index funds can be considered to avoid exit load, as they typically do not charge this fee. However, you should verify the specific terms of the scheme.

Debt funds usually have lower exit loads, making them more suitable for short- to medium-term investments. Among these, liquid funds - ideal for short-term parking of funds (a couple of weeks to around 6 months) - come with graded exit loads for withdrawals within the first 6 days and no exit load from the seventh day.

Overnight funds are even more liquid and are typically used to park money for very short durations (for a week or so). As such, they have no exit load. Keep in mind that exit load is applicable regardless of whether you make a capital gain or loss. The fee is tied to the stipulated time period rather than the performance of your investment.

It is also important to understand that exit load applies in various scenarios beyond simple redemptions:

  • Switching Between Schemes - If you switch from one scheme to another within the same fund house during the stipulated time, an exit load applies because a switch is treated as a redemption.

  • Systematic Transfer Plan (STP) - Similar to switching, exit load can be levied on STP transactions if the transfer occurs within the stipulated time period (depending on the type of source scheme).

  • Systematic Withdrawal Plan (SWP) - Even with SWPs, exit load will still be charged if withdrawals are made before completing the stipulated time period from the date of investment. To avoid this, plan systematic withdrawals only after the specified time frame has elapsed.

When Should You Sell Mutual Fund Units?

Mutual funds are meant for long-term investment purposes and are not intended for frequent trading (buying and selling) like stocks.

Attempting to time your entry and exit in equity mutual funds to navigate market volatility may seem appealing but is highly challenging. Markets are unpredictable, and it's nearly impossible to determine if they have hit the bottom or whether they will rise after reaching a peak.

[Read: Should You Sell Your Mutual Funds Now]

Additionally, apart from exit loads, trading in mutual funds can erode returns due to transaction costs and tax outgo. In the Union Budget 2024-25, presented on July 23, 2024, the Modi 3.0 coalition government has increased the capital gain tax, for both short-term capital gains and long-term capital gains.

Therefore, for long-term financial goals, timing the market should not be your focus. Instead, your investments should be guided by a well-defined strategy.

As long as your mutual fund schemes align with your risk profile, broader investment objectives, and financial goals, and are chosen from fund houses with robust investment processes, effective risk management, and a commendable performance record, you need not stress about market fluctuations.

This does not mean you should never sell. Selling is, of course, an integral part of making investments and generating wealth. However, the decision to sell should be driven by strong and valid reasons rather than market speculation.

[Read: How to Sell Mutual Funds Online: A Step-by-Step Guide]

Here are circumstances where you may consider selling your mutual funds:

  • When your goal is nearing, or you have already accomplished your financial goal(s).

  • When your mutual fund scheme has consistently underperformed.

  • When the fundamental attributes of the scheme have changed (e.g., investment philosophy, strategy, style, or category) and it no longer aligns with your investment objectives.

  • When you want to rebalance your portfolio to address changes in your risk profile or reduce mutual funds with overlapping holdings.

  • When you face financial emergencies.

To Conclude...

When it comes to selling or redeeming your mutual funds, making informed decisions is crucial. Factors like exit loads and taxes can significantly impact your overall returns. The exit load, in particular, is designed to deter premature redemptions, encouraging investors to stay committed to their long-term financial goals.

Therefore, avoid redeeming your investments prematurely unless it is absolutely necessary.

Staying invested with a long-term perspective can not only help maximise returns but also aligns with the essence of mutual fund investments.

Happy investing!

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ROUNAQ NEROY heads the content activity at PersonalFN and is the Chief Editor of PersonalFN’s newsletter, The Daily Wealth Letter.
As the co-editor of premium services, viz. Investment Ideas Note, the Multi-Asset Corner Report, and the Retire Rich Report; Rounaq brings forth potentially the best investment ideas and opportunities to help investors plan for a happy and blissful financial future.
He has also authored and been the voice of PersonalFN’s e-learning course -- which aims at helping investors become their own financial planners. Besides, he actively contributes to a variety of issues of Money Simplified, PersonalFN’s e-guides in the endeavour and passion to educate investors.
He is a post-graduate in commerce (M. Com), with an MBA in Finance, and a gold medallist in Certificate Programme in Capital Market (from BSE Training Institute in association with JBIMS). Rounaq holds over 18+ years of experience in the financial services industry.


Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.

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