What is an Exit Fee?
An exit fee is a charge imposed on an investor when he sells shares or withdraws money from an investment fund before a specified time. The investment industry is full of hidden charges. Exit fees are an example of such costs that can have a considerable impact on an individual’s investment return.
Exit fees are known by other phrases. If the issue is related to annuity withdrawals, then they are known as surrender charges. When dealing with mutual funds, the term back-end load is used. Regardless of the term, the overall impact of an exit fee is a reduction in profit.
Types of Exit Fees
The different types of exit fees share a lot in common. One similarity is that they’re imposed when an individual attempts to exit an investment. Another common attribute is how they are calculated. Most of them are expressed as a percentage of the total return on investment (ROI). So, what are the different forms of exit fees?
1. Early withdrawal charges from a bank certificate of deposit
With early withdrawal charges, an investor is forced to forgo or forfeit part of the profits his investment has earned over a pre-determined period. Most financial institutions require forfeiture of interest earned in the last six to 12 months.
2. Deferred sales on mutual funds
These are commonly known as back-end loads. Basically, a back-end load is a fee imposed on an investor when he sells his mutual fund shares. It is usually expressed as a percentage of the value of total shares sold. A back-end load can be a fixed fee or one that decreases with time – often between five and 10 years. In the latter event, the highest cost that an investor incurs is during the first year.
To explain the concept better, consider this example. Suppose an individual invests a sum of $10,000 in ABC Mutual Fund. The firm charges a 4% back-end load. After some time, the investment increases to $14,000 and the investor opts to sell it. Out of the $14,000 that he invested, he will incur a 4% fee, that is, $14,000*0.04, which is money the company retains. It means that the investor is only entitled to $13,440.
The wise move is to wait until the investment has earned enough gains so that you still realize a satisfactory net profit after paying the back-end load.
3. Redemption fees
Redemption fees are charged to investors who sell their mutual fund shares. However, redemption fees are used for one main purpose, that is, to compensate the remaining shareholders for the handling of the transaction. Mutual fund organizations usually appeal to the investors’ sense of fairness when imposing these charges, and rightly so.
Whenever an investor decides to buy or sell his shares, the fund manager shoulders the administrative costs of accounting for this event. Often, the fund manager is forced to liquidate some fund assets in order to obtain cash to pay out to the investor.
Useful Tricks to Avoid Exit Fees
There are several hacks that investors can use to avoid additional exit fees. The easiest is to exercise due diligence when choosing an investment fund. If an investor does not wish to pay exit fees down the road, then they should start by finding a fund that doesn’t impose such fees. This means carrying out thorough research on the funds available and their respective terms and conditions.
If an investor commits to a fund with such fees, whether wittingly or unknowingly, there are still a couple of things that he can do to minimize the blow. For instance, a majority of fund companies waives exit fees if the investor switches to another fund that they offer. If an investor moves his investment from one annuity to another provided by the same firm, it’s highly unlikely that he’ll incur exit fees.
Another aspect that can work in the investor’s favor is timing. Some fund companies set time limits on exit fees. That said, an investor who doesn’t want to pay exit fees can simply run out the clock and hence avoid paying any exit fees.
Exit fees are charged by investment companies as a way of protecting them from losses that arise from the premature withdrawal of investments. There are many forms of exit fees such as back-end loads and redemption charges. If an individual doesn’t want to incur an exit fee, then he must choose his investment options wisely.
Thank you for reading CFI’s explanation of an exit fee. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: