Mutual funds not only earn for an investor like you but also for asset management companies, advisors, and distributors. This win-win scenario is the reason why mutual funds are all the rage.
But a lot of people wonder “how do mutual funds make money”. If you’re on this blog, you’re one of them and we’re going to dig deeper into the finances of mutual funds.
How Do Mutual Funds Make Money for Investors?
As mutual funds increase in value, investors who own units of the said fund make money in the below three ways.
1. Capital Gains
The goal of investing in mutual funds is to earn profits. These profits are known as capital gains. You as an investor will receive notional capital gains when the mutual fund delivers more money on top of your principal investment.
If you decide to exit the investment by selling your mutual fund units, the profits will be for you to keep after a few cuts in the form of an expense ratio and capital gains tax.
If you know what are mutual funds and how they work, you’ll know that it invests the pool of money in equity shares, bonds, and other financial instruments. Some of these instruments generate a dividend per share, which are nothing but the profit a company redistributes to its shareholders.
The mutual fund which gets these dividends can redistribute them to investors either in the form of money or reinvest it by allocating more units according to the dividend value.
How Do Mutual Fund Companies Make Money?
An Asset Management Company or Mutual Fund Company earns through various avenues. Some charge a fee for you to buy units (on top of the NAV), others may charge you to exit the fund, while some charge both for entering and exiting the fund. Let’s look at all of these mutual fund fees one by one.
1. Expense Ratio
Most mutual fund companies or AMC generates their revenue and profit from the expense ratio. The expense ratio is a percentage of total assets that are required to run a mutual fund scheme smoothly, charged when an investor sells their mutual fund units.
This includes the fund manager’s fee, promoting and selling fee, registrar and distributors’ commission, etc. The expense ratio is calculated as a percentage of the fund’s average Net Asset Value (NAV).
2. Exit Load
In addition to the expense ratio, fund houses charge an exit fee or an exit load if investors decide to leave a scheme before a certain time period which ranges from a few months to 1-2 years. The exact amount of these charges may differ as per the regulations of the company.
3. Entry Load
A mutual fund may charge you a certain amount of money to enter (buy) its units. This is known as an entry fee. Much like the exit load, the entry load varies from AMC to AMC as well as from fund to fund and is calculated as a percentage of the NAV.
4. Units Transfer
If you decide to transfer your fund units to a different fund within the same fund house, you will be liable to pay capital gains tax. The tax itself depends on various factors like the type of mutual fund, your I-T slab, and more.
The question is if AMCs account for distributors’ commissions in their expense ratio, is that the only way distributors gain from mutual funds? And how do mutual fund advisors get paid? Let’s find out how each party involved in mutual funds makes money.
How Do Mutual Fund Distributors Make Money?
The fee or commission earned by mutual fund distributors varies with AMC. Here is the crux of how do mutual fund distributors make money.
1. Upfront Fee
Once an investor buys a mutual fund scheme at the behest of the distributor, they earn an upfront fee from the fund house. The AMC charges for it from the investor on the purchase of equity, debt fund, and hybrid schemes.
2. Trail Fee
Distributors are also entitled to a trail fee, which is paid to them by the AMC for as long as the said investor decides to remain invested in the scheme.
Mutual fund distributors might receive fresh investments from their advisors. How do mutual fund advisors get paid? They earn an income as a fixed percentage of the investor’s portfolio or through commissions paid by distributors or AMCs.
Why Cost Matters When Investing in Mutual Funds
Choosing the right mutual funds in India requires a good understanding of the fund’s track record, portfolio, and costs associated with it. Knowing the costs involved in a mutual fund before investing is crucial because it can have a significant impact on your returns over time.
The expense ratio, advisory and management fees, and any commissions for fund distributors add up and can reduce your returns. By understanding the costs, you can make an informed decision about whether a particular fund is worth the investment.
Additionally, it’s important to compare the costs of different funds to ensure you’re getting the best deal. Before you head to invest in a mutual fund, you can check out an online investment platform that allows you to invest in mutual funds in a cost-efficient, fast, and secure manner.
Mutual funds have become a go-to investment option for several investors. Due to their sheer potential, mutual funds are capable of making money not only for investors but also for fund companies, distributors, and advisors.
While investors and AMCs earn profit from a rise in the value of fund assets, distributors and advisors make money from bringing in fresh investments and keeping them invested. It’s best to keep an eye on all the mutual fund fees so that you know exactly how much you have to pay.
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