How do Direct plans in Mutual Funds make a difference to your long-term returns?

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The regulations in the mutual fund industry have evolved over time and in the best interest of investors. After the abolition of entry load in 2009, the SEBI introduced zero-commission, i.e., direct plans in 2013. This means that you as an investor can directly buy mutual funds from the fund house with no distributor/broker/agent in the picture. Thanks to the internet and the various digital platforms available today, it has become even more easier now to buy mutual funds directly online.

 

What is the difference between direct and regular mutual fund plans?
Be it a direct plan or regular plan of any mutual fund, the fund manager, investment objective, risk factors, number of stocks in the portfolio all remain the same. The difference is that regular plans charge an investor, commission in the form of distributor expenses and trail fees. These are paid from your pocket by the fund house to the middlemen who bring business. The commission is included in the total expense ratio of the fund. The amount of commission varies on an average between 0.5-1.25 per cent per annum. This is reflected in the net asset value (NAV) of your fund. Whereas, in the case of direct plans, there is no broker/distributor commission. Due to this difference in expense ratio, you surely earn more than by investing in a regular plan.

Why have direct plans not caught up with investors?

Despite SEBI’s noble intentions, direct plans have not really caught up with investors. After about six years of direct plans being launched in 2013, only an estimated 5 per cent of the investors have directly bought mutual funds as on date. The reason for this abysmally low proportion of direct investors is because:

  •  Majority investors are unaware of direct plans, the awareness level is abysmally low.
  • Even if they do, they are ignorant of the fact that they can shift from regular to direct plans.
  •  Investors do not fully comprehend the impact cost of investing in commission-based plans rather than direct plans over the long term.
  • Investors are dependent on their distributors for execution of services like filing up forms and other paper work. So, they choose commission-based plans.

How direct plans create greater wealth than regular plans over long term?

As mentioned earlier, direct plans have lower expense ratio than regular plans. As seen from the table below, the average difference in expense ratio between a direct and regular plan is about 1 per cent. While this may appear minuscule, it can balloon into a huge number over the years with the power of compounding. This 1 per cent difference in commissions eats up into your investment every year – yes, every year. The long-term compounding impact of this 1 per cent on your returns cannot be undermined as shown in the table below.




If you invest Rs.5 lakh over 5 years, the difference in absolute returns between a direct and regular plan can grow to over Rs.60,000 as illustrated in the table. The higher the investment amount, the higher the difference. For an investment of Rs.10 lakhs, the difference can balloon to over Rs.1 lakh on an average.

Where can you buy direct mutual fund plans?

Your first option is websites maintained by the respective fund houses. The transactions on these portals are entirely free. You have the comfort of directly dealing with the fund house here. The only hitch is that you would have multiple login accounts and have to manage all the accounts which include remembering login details, checking the valuation, updating all fund holding details, etc. This would be a pain especially if you have too many holdings of different fund houses. If you a prefer a single platform to manage all your mutual fund holdings, then there are many online sites likes MFU utility, Coin, Invezta, ClearFunds, Kuvera, etc. Every platform has different features and pricing while some are absolutely free.

If you are a (Do it Yourself) DIYer, having good investing experience and knowledge of the markets and mutual funds, then it is prudent to go for direct plans. If you do not understand mutual fund investing and do not have the time to manage your portfolio, then you can go for a professional Investment Advisor who will manage your investments through direct plans with unbiased advice. A small breed in India yet, most of these are registered with SEBI and are known as Registered Investment Advisors (RIA). They follow a strict code of conduct and adhere to professional regulations laid down by SEBI.

An RIA will not earn any commission from recommending any mutual funds, so there will be no conflict of interest. He will charge a flat fee or AUM based fee for his services. His services will include your risk profiling, recommending mutual funds in line with your risk appetite, execution of transactions, portfolio management including tracking and rebalancing, etc.

To conclude, go for direct plans as it will make a substantial difference to your total returns of a fund over the long term.

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