What Young Investors Should Know About Direct Plans of Mutual Funds

There is a lot of media hype nowadays on direct plans. People say they are cheap, so they go for them. As a newbie investor to mutual funds, what should be your approach? What if you have a substantial portfolio of regular plans of mutual funds? We talk about all these aspects in this article to help you make a sound decision as an investor.

What are the direct plans of mutual funds

When you invest in mutual funds, it does not come free of cost. A mutual fund company charges a small amount (known as the Total Expense Ratio) in return for the management of your investment. The mutual fund company does not send you an invoice for this amount. The amount is automatically deducted from the Net Asset Value of the mutual fund scheme on a daily basis.

In October 2012, SEBI took a bold decision in the interest of investors by asking mutual fund companies to issue a separate “direct” plan for all their schemes. The investor needs to purchase these plans directly from the mutual fund company, resulting in zero involvement from the distributor/middlemen. This allows the mutual fund company to charge a lower expense ratio from the investor. The company doesn’t need to pay the commission to the distributor.

What are the advantages of direct plans?

The only advantage that a direct plan holds over a regular plan is a lower expense ratio. This translates into a higher NAV and higher returns over time. Let us understand this with the help of an example.

As per the April 2021 Factsheet of HDFC Mid Cap Opportunities Fund, the expense ratio applicable for the regular and direct plan is 1.79% and 1.08%. This amounts to a difference of 0.71%. Consequently, the return of a direct plan will be more than that of a regular plan by this margin. Let us assume that you invest INR 10,000 per month for the next 20 years in both plans. Let us also assume that the return for the regular plan is 10%. Given the difference in expense ratio, let us assume the return for the direct plan to be 10.71%.

In such a scenario, the corpus accumulation in direct and regular plans will be as follows:

Plan Type Assumed Return % Corpus Value (INR)
Regular  10 75.94 lacs
Direct 10.71 83.32 lacs

This means that if you invested in a regular plan, you lose out on INR 7.38 lacs over 20 years ( ~ 8.86% of the total corpus value under the direct plan). This difference is significant enough not to be ignored. Hence, from a returns perspective, it makes a lot of sense to invest in direct plans.

What are the disadvantages of direct plans?

However, it is never good to make an investment decision going by returns as the only criteria. You should also make yourself aware of the points you’ll miss when you invest in direct plans. That will help you make a balanced decision. When you invest in a regular plan and have a good distributor to support you, you can expect the following services:

  • Advice regarding schemes suited to your financial profile
  • Assistance on investment, which includes completing the necessary paperwork etc.
  • Reminding you of your investment due dates
  • Helping you renew your SIP once the period is over
  • Handholding you in difficult market situations

Take note: You do not get the above support when you invest in direct plans.

Should you shift to direct plans of mutual funds?

There is no clear yes or no answer. There are three possible options as follows:

#1: Going direct:

You earn a better return on your investment. This compounds over time and makes for a sizeable difference (as explained in the example earlier). However, you are alone for all practical purposes. You don’t have anyone to guide you or to cross-check on your investment decisions.

#2: Staying with the regular plan:

This is a good option if you prefer some handholding and guidance from an adviser or have an existing relationship with a good financial adviser.

#3: Going with Direct Plans + Engaging a fee-only adviser:

This is a middle path. Here, you hire a good SEBI Registered Investment Adviser (RIA) and pay him/her a flat fee. In return, the adviser helps you invest in direct plans of the suitable schemes as per your financial profile. On the one hand, you get the benefit of investing in direct plans. On the other hand, you get conflict-free advice that is in your best interest.

What should you keep in mind while shifting to direct plans?

Below are some tips to help you navigate the shift to direct plans of mutual funds a hassle-free and seamless affair:

  • Selling your mutual fund investment can cause taxation and exit load implications. If you have a substantial portfolio, you may proceed as per the guidance of an adviser to minimise the loss.
  • Investing in direct plans can cost you heavily if you are not diligent enough, as you may end up choosing low-performing schemes. This can make it a “penny-wise-and-pound foolish” decision.
  • If you stick to a regular plan, you have the right to demand full service for the higher expense that you bear. Be willing to change your mutual fund distributor if you don’t find the services of your existing distributor effective.

Conclusion

Direct plans have been a customer-friendly move by SEBI for investors’ benefit. They can definitely help you earn better returns in the long term. But it is essential to not focus on returns alone and look at the whole thing holistically. A wise approach will be to first upskill yourself in mutual funds and/or engage a fee-only adviser before making a shift to direct plans.

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