How do mutual funds make money?

Nobody is doing charity while running a mutual fund. Every organization keeps profit as its key motive while running any fund. They do put some costs on their products. So, as a consumer, you need to understand costs really well so you can decode not only mutual funds but other products as well.

In this article, we are going to discuss different costs that a consumer should keep in mind before buying any product. Also, in the end, at every cost, we have mentioned specific questions which one should ask before buying these products.

A market-linked investment product carries three kinds of costs:

1. Front-load: Cost to enter the product. For example, if you invest Rs 100, and Rs 2 from that is cut out so that Rs 98 is invested, then Rs 2 is called a load. A load is a part of the price of the product which is usually not disclosed. So, the ideal question here to ask is: How much of the money I invest goes to work?
2. Expense Ratio: An ongoing cost or annual fees that you need to pay to have experts manage your money. This is a cost that mutual fund charges investors for its costs and profits it makes. The market regulator has put ceilings on how much a fund can charge you. For example, for a liquid fund, it’s around 14 paise to Re 1 for every Rs 100 invested every year, and for an equity fund, this value can range from about Rs 2 to Rs 3. These numbers may look small but they add up to be a significant amount over the years. For instance expense ratio of 0.5 percent and 1.5 percent over a 20 year period is huge. If you had 1 lakh investment in both, one scheme will give you Rs 15 lakhs, and the other will give you 12.58 lakhs. Costs matter do look at the expense ratios of the funds you buy.
3. Exit cost: Cost of selling the product. To take care of expenses of selling the investment you made or to act as a deterrent to frequent churning of money, funds levy exit charges. So question to ask here: What does it cost to redeem this product after one, two, three years, and so on over the life of the product.