What to keep in mind before investing in direct mutual fund plans?

There are two sides to Direct Plans. On the one hand it saves you the sales commissions and improves returns. On the other hand, since you are investing on your own, you lost out on the benefit of a professional advisor.

Apr 09, 2019 12:04 IST India Infoline News Service

At the 2016 Annual General Meeting of Berkshire Hathaway, Warren Buffett marked out an unlikely investment hero in the form of John Bogle. Unlikely; because Buffett has epitomized active investing while Bogle has long been a votary of passive investing! The difference between active investing and passive investing is about the lower cost. We can extend this argument to Direct Plans versus Regular Plans. In Direct Plans, customers don’t have to pay the sales commissions as they invest directly. This lowers their expense ratio (TER) and increases their NAV. Direct Plans benefit from lower cost, just like Bogle’s index funds benefited from lower costs.
 
Extending the Bogle argument to Direct Plans
 
There are two sides to Direct Plans. On the one hand it saves you the sales commissions and improves returns. On the other hand, since you are investing on your own, you lost out on the benefit of a professional advisor. By making investors directly approach the AMC for investing in mutual funds rather than going through brokers, Direct Plans save a lot of money for investors. This is instrumental in generating wealth. This factor can become more meaningful as the overall mutual fund participation increases. Out of the total mutual fund corpus of Rs25 trillion, equity funds account for nearly 1/3rd of the AUM. On a monthly basis, SIP inflows are to the tune of Rs8020 cr ($1.2 billion) as per AMFI data for December 2018. With a rising trend towards financial savings and investments, lower costs will matter and hence Direct Plans become relevant.
 
7 points to remember when investing in Direct Mutual Fund plans

Direct plans are not just about lower costs and better returns but a lot more. Here is why.
  1. Direct Plan applications are typically made directly to the AMC or through the registrar websites or using aggregator (MFU) platforms. On the other hand, Regular Plans are convenient in that you can rely on a broker to take care of the procedural aspects.
  2. What about investment advice? That is where regular plans score over direct plans. Since you are directly making the application, you don’t get the benefit of fund selection, fund mix analysis, portfolio advice etc. In a regular plan, you can get most of these services from your broker.
  3. Direct Plans are suited to investors who are familiar with the mutual fund product and have the wherewithal to screen and select funds for investment. In case, you are new to mutual funds or do not have the time to spare, then you must use the services of an advisor and go through a Regular Plan.
  4. Direct Plans are not cost free, as some might be inclined to believe. Some of the costs like administrative costs, fund management costs, branding costs, audit fees, registry charges etc are billed to the Direct Plan too. It is only the distributor commissions and trail commissions that are not billed to the Total Expense Ratio (TER) in case of Direct Plans. TER is the proportionate cost of managing the fund that is billed to the NAV of the fund on a daily basis.
  5. When can you opt for a Direct Plan? If you are relying on an independent financial planner for advice, then the advisor takes care of selecting the right funds for you. In that case you can opt for Direct Plans and reduce costs. However, if you are looking to your broker for advice, then it is always better to opt for the Regular Plan.
  6. The advantage of a Direct Plan over Regular Plan can be assessed in terms of the additional wealth created. One important criterion is the tenure of holding. For example, the wealth advantage in a Direct Plan may not be significant if you are investing for 3 years. But for investments beyond 10 years, the advantage of a Direct Plan can be quite significant. Longer the tenure of the fund, greater the impact of the Direct Plan.
  7. Lastly, the market returns of the fund also matter. For example, the typical advantage that Direct Plans get over Regular Plans is around 60-70 basis points in terms of lower TER. This advantage becomes more pronounced when the markets returns are low. In such cases, lower costs in Direct Plan can add to your effective returns a lot more in difficult markets. 

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