What is Entry Load and How it works

Simple definition

An entry load is a fee that mutual fund companies used to charge investors at the time of purchasing fund units. This fee was typically a percentage of the investment amount and was deducted upfront. For instance, if an investor allocated Rs. 1,00,000 to a mutual fund with an entry load of 2%, Rs. 2,000 would be deducted as a fee, and only Rs. 98,000 would be invested in the fund.

The primary purpose of the entry load was to cover distribution and marketing expenses incurred by the mutual fund company. However, this fee directly impacted the amount of money an investor could allocate towards their financial goals, making it a contentious issue among retail investors.

How does an entry load work?

Mechanism and example

Before its abolition, the entry load was calculated as a percentage of the total investment amount. Here is a step-by-step explanation of how it worked:

1. Investment Amount: The investor decides to invest a specific sum in a mutual fund.
2. Entry Load Deduction: The mutual fund company deducts the entry load percentage from the investment amount.
3. Net Investment: The remaining amount, after the deduction, is used to purchase fund units.

Example:

If an investor wanted to invest Rs. 50,000 in a mutual fund with an entry load of 2%, the calculation would be:

• Entry Load = 2% of Rs. 50,000 = Rs. 1,000
• Net Investment = Rs. 50,000 - Rs. 1,000 = Rs. 49,000

The investor would receive mutual fund units worth Rs. 49,000, reducing the initial capital available for compounding.

Descriptive explanation

The Securities and Exchange Board of India (SEBI) abolished entry loads in 2009 to promote investor transparency and fairness. This decision was driven by the need to protect retail investors from high, opaque charges that eroded their returns. SEBI’s regulation mandated that all fees and commissions be explicitly disclosed to investors, ensuring that they were fully aware of the costs associated with their investments.

By eliminating entry loads, SEBI empowered investors to allocate their entire investment amount towards mutual fund units, thereby enhancing their potential returns. This move also encouraged mutual fund companies to adopt a more client-centric approach, focusing on performance and service quality rather than relying on upfront fees.

Entry load vs. exit load: A key differences table

Key charges to consider

Although entry loads are no longer applicable, investors should be aware of other charges that can impact their returns:

1. Expense Ratio: This is the annual fee charged by mutual fund companies to manage the fund. It includes administrative, management, and operational expenses. A lower expense ratio ensures higher returns over the long term.
2. Exit Load: This fee is charged when investors redeem their mutual fund units before a specified period. It is typically a percentage of the redemption amount and is designed to discourage early withdrawals.
3. Transaction Fees: Some mutual fund companies charge a one-time transaction fee for investments above a certain threshold. While these fees are relatively small, they can add up over time.

Pro Tip: Always review the scheme information document (SID) and key information memorandum (KIM) to understand all associated charges before investing.

How entry loads historically impacted investor returns

Key points on impact

Entry loads had a significant impact on investor returns, particularly for those investing smaller amounts or seeking higher returns through compounding. Here is how:

• Reduced Invested Amount: A portion of the investment was deducted as an entry load, leaving less capital to grow over time.
• Lower Compounding Base: Since the initial investment amount was reduced, the compounding effect on returns was also diminished.
• Higher Hurdle Rate: Investors needed to achieve higher returns to compensate for the upfront deduction, making it harder to meet their financial goals.

By abolishing entry loads, SEBI ensured that investors could fully benefit from the power of compounding and maximise their wealth creation potential.