Despite being explicitly prohibited, the practice of rebating or passing commission continues to be a rampant one in the mutual fund industry. Simply put, mutual fund distributors and investment advisors remit a part of their commission earnings back to the investors thereby rewarding the investors for making investments through them. From the distributor's perspective it is an opportunity to retain his clientele; on the other hand, the investor makes some money on the side (which he is legally not entitled to).

Before we discuss if the practice of accepting rebates is worth the investor's while, let's find out how the rebate mechanism works. Generally rebates are computed as a percentage of the distributor's income. For example if a distributor makes 3% upfront commission on a lump sum investment in a diversified equity fund investment, he pays the investor about half of the same i.e. 1.5% of the amount invested. Hence investing Rs 20,000 in a diversified equity fund could fetch you a rebate of Rs 300.

Now let's take an example to understand how much an investor accepting rebates really stands to gain. Suppose the investment amount is Rs 50,000 and rebate offered is 1.5% on the same i.e. Rs 750. Consider 2 situations, the first one where no rebate is being offered and secondly when the investor gets a rebate. We shall assume that the rebate amount is reinvested in the fund. Also the mutual fund charges an entry load of 2.50%.

Hence in case 1, the real amount working for the investor is Rs 48,750 (Rs 50,000 minus 2.50%); in case 2, the amount is Rs 49,500 (Rs 48,750 plus Rs 750).

Does the rebate matter?

Investment Tenure - 3 yrs
(Rs)	Case 1	Case 2
Investment Amount	50,000	50,000
Entry Load	2.50%	2.50%
Net Amount Invested	48,750	48,750
Rebate	-	1.50%
Amount of Rebate	-	750
Effective amount invested	48,750	49,500
3 yr return (pa)	10.00%	10.00%
Maturity value of investment	64,886	65,885
Effective Return on Investment Amount	9.08%	9.63%

Assumption - The amount of rebate in reinvested in the same scheme

Assuming that the investment fetches a steady return of 10% per annum and no charges are levied by the fund house, the investments would be worth Rs 64,886 and Rs 65,885 for case 1 and 2 respectively at the end of a 3-Yr period. Hence the investor accepting a rebate would be richer by approximately Rs 1,000 or would have an additional gain of 0.55% to show for. Interestingly, if both the investors stay invested over a 5-Yr period, the difference in returns due to rebates declines; the difference which stood at 0.55% over 3 years drops sharply to 0.34% over 5 years.

Apart from circumventing the law, the investor accepting rebates could be taking on a significant risk of getting invested in the wrong avenues. This in turn might lead to non-achievement of his financial goals and objectives. Here's a thought - the distributor offering rebates actually parts with a part of his income. Ever wondered the objective for doing so? Does he do that to make good some deficiency in his ability to recommend the right investments or to cover up his poor service standards?

Conversely, investors have the option of dealing with an investment advisor/distributor whose USP is providing then right advice coupled with high service standards. Distributors of this variety compensate investors by recommending appropriate schemes and ensuring that their client's objectives and goals are met. In the illustration above, the individual investing Rs 50,000 earned an additional Rs 1,000 over a 3-Yr period. Wouldn't sacrificing the measly rebate be a small price to pay for being associated with such a distributor?

That's a question for investors to ponder over. Choose a distributor who offers you a rebate and in the process might expose your financial planning to risk (thanks to his incompetence); on the other hand you can select a distributor who delivers on the right parameters  advice and service. Spare a thought on this the next time you decide to get invested.

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