What are the benefits of investing in direct plan of a mutual fund?

• Direct plans are cost effective because you save distribution costs and trail costs and that result in lower TERs and a higher NAV. Lower costs in direct plans translate into higher NAV and better returns.

Apr 02, 2019 02:04 IST India Infoline News Service

Direct plans, where you invest in mutual funds without intermediation, have been around for nearly 6 years now. While the Direct Plans did not take off immediately, investors are beginning to see merit in opting for a Direct Plan. Essentially, direct plans do away with intermediation and that saves you the intermediation costs. Since Direct Plans are not charged the distribution and trail costs, the total expense ratio (TER) is much lower in their case. Let us look at some key benefits of opting for a Direct Plan.

Merits of the Direct Plan approach to mutual funds
• Direct plans are cost effective because you save distribution costs and trail costs and that result in lower TERs and a higher NAV. Lower costs in direct plans translate into higher NAV and better returns.

• Direct Plans make the entire mutual fund investing process quite simple. Most equity fund investors in India have a small corpus to invest. Such a corpus does not require too much of complexity and nuanced analyses. Direct Plans can work best in such cases.

• Direct Plans give the investor an opportunity to directly interact with the fund. In the Regular Plan approach, it is the broker who takes the entire onus and thus you are hardly familiar with the final product or even the AMC. In case of direct investing, the investor directly interfaces with the AMC and a direct link is built with the principal.

• Direct Plans enhance returns a lot more when we talk about a longer time frame. Mutual fund SIPs are based on the compounding principal and hence the cost-benefit of Direct Plans gets compounded over a longer period. That makes the Direct Plan a lot more meaningful over longer time frames of 10 years plus.

• Direct Plans also work better and with greater impact when the returns in the markets are lower. In a high return scenario, you don’t worry about the additional cost. But in a scenario when the markets are volatile and alpha gets tougher, Direct Plans can make a much bigger difference.

• Even if you have a direct plan, you can still go to an investment advisor for guidance on investing and managing your mutual fund portfolio. This actually delineates your advisory and investment function and makes it more objective.

Proof of the pudding lies in the eating: How much is the Direct Impact

The Direct Fund selection typically has a bigger impact over a longer time frame. Let us take a time frame of 10 years and assume that the NAV grows at 14% CAGR over the next 10 years. Let us also assume that the TER of the Regular Plan is 2.50% while the TER of the Direct Plan is 70 bps lower at 1.80%. What is the wealth impact?
CAGR Ret 14% REG TER 2.50% DIR TER 1.80%
Regular Plan Direct Plan
NAV Post TER Yield Net NAV NAV Post TER Yield Net NAV
Year 0             100.00 11.50%      111.50          100.00 12.20%          112.20
Year 1             111.50 11.50%      124.32          112.20 12.20%          125.89
Year 2             124.32 11.50%      138.62          125.89 12.20%          141.25
Year 3             138.62 11.50%      154.56          141.25 12.20%          158.48
Year 4             154.56 11.50%      172.34          158.48 12.20%          177.81
Year 5             172.34 11.50%      192.15          177.81 12.20%          199.51
Year 6             192.15 11.50%      214.25          199.51 12.20%          223.85
Year 7             214.25 11.50%      238.89          223.85 12.20%          251.16
Year 8             238.89 11.50%      266.36          251.16 12.20%          281.80
Year 9             266.36 11.50%      296.99          281.80 12.20%          316.18
Year10             296.99 11.50%      331.15          316.18 12.20%          354.75
Direct Plan Wealth Advantage 7.13%

The wealth advantage that is created by the Direct Plan due to lower TER is about 7.13% over a 10-year period. If you are looking at a reasonable MF portfolio value of Rs3 cr at the end of 10 years, then the selection of the direct option will save Rs21.39 lakhs on your corpus.  That is certainly a big difference and worth fighting for. Of course, the caveat remains that you need to be a lot more self-sufficient; both in terms of investment decision making and also the procedural aspects.

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