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Personal Finance

Mutual Fund Commissions on Tax Saving Schemes

Since some of you will be investing in tax saving schemes for the rest of the year, note that there are pretty good commissions being offered to advisors for selling the scheme. The most recent mail I have:

tax saving schemes

Upfront is what advisors get paid when you invest. Trails are after 1 year of holding, 2 years of holding etc.

How can they pay such high commissions? In tax saving schemes, your funds are locked in for three years. Each year, there is a 2.5% management charge AMCs can take – for a total of 7.5% – of course some AMCs charge lesser fees but I wouldn’t count on less than 2% a year, due to these high commissions.

Will fund performance suffer? Er…nearly every mutual fund is trying to max out its AMC fees now to pay upfront commissions and new schemes are on “special commissions” every day. So EVERY mutual fund house is likely to max its commissions. Therefore, relatively speaking, there may not be much of a problem. And if the fund can grow by 2.5% – it’s management fee – it’s all even. (And most AMCs must believe they can, because heck, the GDP is growing 6%)

Does it make more sense to go DIRECT?

Let’s do the calculations. Assume a fund with 100 investors with Rs. 100,000 each , all of whom come through advisors. The fund has a corpus of 1 crore, and can charge Rs. 2.5 lakhs as expenses, or Rs. 250,000. This can be split as:

Upfront: Rs. 100,000 to advisors (Rs. 1000 for each investor’s advisor – or 1% upfront)
Trail: Rs. 50,000 (Rs. 500 or 0.50% 1st year trail)
AMC retains: Rs. 100,000 for it’s management expenses and profits.

Each advisor makes Rs. 1,500 as commissions and the AMC gets 100K.

Think about what happens if the fund becomes 50 advisor-based investors and 50 Direct investors. The Direct investors have no commissions – upfront or trail. The fund can still charge Rs. 250,000 as fees – since SEBI permits 2.5% to be charged. That can then be split as:

Upfront: Rs. 75,000 to advisors (Rs. 1,500 for 50 advisors, or 1.5%)
Trail: Rs. 50,000 to advisors (Rs. 1,000 per advisor or 1%)
AMC Retains: Rs. 125,000.

Each advisor gets Rs. 2,500 and the AMC gets 125K.

(Note that commissions here are higher on a % basis, because the fund house is charging 2.5% but distributing among lesser advisors – it can therefore offer higher % commissions)

Basically, if you go DIRECT, you are supposed to get better fund management due to lower commissions – but as you can see, in practice it means that advisors stand to make more. If anything is left, the AMC rakes it in.

AMCs complain that people are being guided towards insurance products which offer huge commissions; so mutual funds have to compete. That is true and IRDA should also ban all upfront charges. If anything, insurance is an even worse investment.

Yet, Mutual funds need smarter investors but as you can see above, the smarter ones will figure out the commission scales are tilted against them. Smarter products must be brought – for one a zero load, low cost mutual fund will be nice. I will be happy to see a no-load fund with expenses capped at 0.5%. I know that Nifty BEES (An exchange traded fund from Benchmark) fits the bill – you do pay some brokerage getting in though. (As Commenter DK points out, Nifty BEES is not an ELSS fund, so that’s not quite a tax saving instrument) Quantum Mutual fund has no load but it charges 2.5%, thus negating any no-load benefit.

Disclosure: I am an AMFI registered individual and can get these kind of commissions if I want to sell them. And it’s entirely legal to disclose these commissions – in fact by new SEBI rules you are required to do so if you are an advisor.

It’s against AMFI guidelines to pass this brokerage back to the investor, but many advisors still do it: if your advisor is passing commission back, now you know how much to ask of him!

(On that note I think it should be perfectly legal to pass commissions back. If an advisor wants to pay back commission why should there be a rule to stop him from doing so? It’s a big-brother rule that makes no sense at all, so it happens without any real enforcement. But since it is not allowed, so no one can openly say they are giving commissions back)

I am in the process of registering with mutual funds as an advisor, and feel free to contact me for any support. If any advisor is not selling you a fund because he is not getting any or enough commission, please let me know – I can help. I don’t care about upfront commissions at all.

  • Vishal Gehi says:

    >Nice update and good to go through the statistical data. I believe mutual funds are the best way to save tax and grow your money too.

    Would be nice if you include UTI Mutual Funds as well. UTI Mutual Fund also has Equity Tax Saving Plan.

    http://www.utimf.com/webniar/ETSP/etsp_webinar.html

  • Deepak Shenoy says:

    >Vishal: Found out. UTI MF gives 1.5% upfront, 0.50% on first year trail and 0.40% on subsequent years. (I'm empanelled with them )

  • Madhab says:

    >In the 2nd comparison the upfront Advisors commission is 1.5% but in the 1st it is 1.0%. Why the difference? Same with Trail as well?

  • Deepak Shenoy says:

    >Madhab: SOrry for the confusion. The concept is that the fund house has the same amount to distribute but among lesser advisors, so it offers more commissions.Have updated the post.

  • Madhab says:

    > Upfront is what investors get paid when you invest. Trails are after 1 year of holding, 2 years of holding etc.

    I guess Upfront is what the AMC and Advisor gets paid for when we invest?

  • DK says:

    >Deepak: You mentioned Nifty BEES, but that is not an ELSS right?

    Anyway, is anyone investing anything in ELSS this year?

    I thought everyone feels that India is "overheating" and should wait?

    On a totally unrelated note, is there a better alternative to an ELSS this year? (Yeah I know, I should do the research, but even after doing much research, I am still not able to make a decision).

  • Deepak Shenoy says:

    >Madhab: Good catch thanks – fixed.

    DK: Very good point 🙂 I shall update the post, thanks.

  • DK says:

    >Whoa. You are up this early on a Saturday? (I am in the US this week (with my undies intact), its friday noon for me).

    With your latest post on playschools, I would guess your kid is keeping you awake …

    P.S. I like the upper case "C" for commenter.. Makes it sound like a title or something.

  • Anand says:

    >Hi. I dont understand the reason why SEBI has made it mandatory for the advisors to disclose how much they are getting from the fund for selling the schemes. By the same logic, should a dealer of LG television tell us at what cost LG is giving him the TV and how much money he is making on the same.

  • Deepak Shenoy says:

    >DK: I hadn't slept. Was designing a system. Took me too long 🙂

    Anand: The financial industry is a lot more open than the TV industry.

  • Oracle says:

    >Nice post and this is not what you get to know from your mutual fund advisor. Hence important.

    I smell something like 'fundsindia like platform' in future from you.

    About your habit of getting up early , I see some tweets at around 5am from you, which is great.

  • Soumya says:

    >Pls let me know how can I register myself as an insurance advisor. I am investing around Rs. 50000 every year. It would be helpful if I can save the upfront charges for myself.

    Regards,
    S.J.Ghosh
    soumya.talking@gmail.com

  • Deepak Shenoy says:

    >Soumya: You don't get commissions on your own investments. Can channel them as family investments and make some cash though. Check out the AMFI web site on how to become an advisor.

  • Anonymous says:

    >Hi Deepak,

    I want to buy car, can u have explain how can I buy the car without dealer's commission? I thing it is cheaper for me (i thing all of us)if I buy directly from company like mutual fund.

  • Deepak Shenoy says:

    >Anon: You *CAN* buy a car directly without dealer's commissions, mate, if you know how! taxi companies like Meru tend to ink direct deals. In fact car commissions are very very little nowadays – the dealers make most of the money from service and spares.

    Secondly, compare buying a fund to buying another investment – such as real estate, bonds or shares. You can buy through brokers, or you can buy direct (for shares, think IPO). In real estate, it's cheaper to buy direct but sometimes brokers will offer you zero commission rates. Shares cost more to buy through a broker than for an IPO (an IPO has zero commissions paid by you).

    In all investments the intermediary costs can be eliminated with very little impact. Not so for consumption items like toothpaste or medicines; but even there, for a large volume, you can deal directly.

    In this context, I don't grudge advisors their commissions. I think they should charge investors directly – your advice costs X, beyond that if the customer wants, they can buy fund direct or through you, where you will make commissions paid out by the fund.