Mutual Funds: Why You Should Opt For a Direct Plan..!
by Ms. Nehal Joshipura, DSIMS, Mumbai
In 2012, the Securities
and Exchange Board of India (SEBI) had mandated mutual funds to differentiate
between direct and distributed plans in mutual fund (MF) schemes. It was
implemented from January 2013.
Direct plans give higher
returns than regular plans because of the lower expense ratio.
Investors can buy direct
plans of mutual finds from asset management companies (AMC) directly and save
on the commission paid to the distributors.
The idea is that those
investors who are not using the sales channel should not bear the cost of
distribution. If an investor can identify suitable good funds to buy and do
documentation like form-filling and KYC, then why would he pay commissions?
This path-breaking move
provides an edge to investors investing in direct plan without any incremental
effort. This was done to promote the direct plans, that effectively invest more
of the savings and help investors earn extra return.
A regular plan is sold
by an independent financial advisor
(IFA) or a distributor of mutual fund AMC. The IFA gets 0.75-1% as upfront
commission and annual trail commissions on continued investments of 0.5-0.75%.
It helps in selecting the plan according to the investor’s risk profile and
does the required documentation.
Alternatively, SEBI registered investment
advisors, operating on ‘fee only’ model can help an investor select the right
funds for a fixed fee, which is much lower than upfront and trail commissions
paid to distributors.
The impact is more
significant for systematic investment plans (SIPs). Every SIP contribution is
treated as fresh investment and distributor gets upfront commission on every
SIP contribution and a trail commission on accumulated corpus.
So far as documentation
is concerned, it is better to handle your KYC (Know
your customer) proofs yourself instead
of giving it to someone.
Also, you can specify
email, phone number, nominee details, etc., as you want. Many schemes are
offered online from fund website and platforms like CAMS.
Let us understand the
impact of upfront and trail commissions on wealth creation in an equity fund
where the expense ratio for direct plan is lower by 0.7% than that of regular
plan.
Suppose you have annual
investment of Rs. 6 lakh in a mutual
fund scheme which earns 14% return. Assume that you begin investing at the age
of 30 and continue till retirement at 60.
Now, direct plan gives
you 14% annual return. However, since due to commissions paid out of your
money, NAV of regular plans will be lower and give you about 13.7% per annum
return. Further, if the amount is reinvested at the time of retirement into a
conservative scheme till age 85, this investment continues to earn 10% in
direct plan and 9.7% in regular plan.
The impact over the
lifetime on total wealth created is huge. The difference at the age of 60 is a
whopping Rs. 2.76 crore.
If the investment is not
withdrawn till the age of 80 and 85, the difference widens due to compounding
effect and becomes more than Rs 73.78 crore and Rs 134.98 crore, respectively.
Recently, SEBI has asked
funds to clearly disclose commissions and incentives passed on to distributors
along with visual representation.
So, why not increase
your effective return on your investment by investing directly. Or, pay your
advisor a one-time fee for selecting the right fund and avoid paying
commissions to a distributor.
About the author..
The author, Nehal
Joshipura is faculty member in the finance department at DSIMS, Mumbai
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