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Why You Should Opt For Direct Plans While Investing In Mutual Funds - Outside View by PersonalFN
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Why You Should Opt For Direct Plans While Investing In Mutual Funds
May 2, 2016

"Don't judge each day by the harvest you reap but by the seeds that you plant."- Robert Louis Stevenson

A few years ago when mutual funds started offering direct plans, it was expected that the retail investors would favour the new concept. Although it remains popular among genuine investment advisors, individual investors have found little merit in them so far, at least going by numbers. People seem to have forgotten the above axiom. Some investors are unaware of benefits while others tend to be ignoring resolutely.

As per the data published by the Association of Mutual Funds in India (AMFI) only around 10% retail investors invest in direct plans. The percentage is little higher - close to 15% - in the case of High Net-worth Individuals (HNIs). What's more shocking is, out of total equity assets held by individuals, just 5.0% come through the direct route.

Before you read about what investors are missing by not opting for the direct route, it is worthwhile to understand the basic concept once.

What are direct plans?

Almost all mutual funds offer you broadly two plans to invest in their schemes, namely direct plans and regular plans.

Direct Plan - Opting for this plan while investing in mutual funds, you eliminate the services of a mutual distributor / agent / relationship manager. The transaction may be performed online or even physically by visiting the registrar's or the asset management company's office.

Regular Plan - This has been the conventional way wherein, you push your request to transact vide mutual fund distributor / agent / relationship manager.

What was the rationale behind encouraging investors to invest directly?

The idea was, if investors approach mutual funds directly to transact, the fund houses would be able to cut off the long chain of distributors and agents which always adds to their cost structure. In return, the mutual fund houses would pass on these cost savings to the investors in the form of the lower expense ratio. The expose ratio tells you how much as a percentage of the scheme's corpus the total expenditures are. This was considered to enhance the returns for the investors.

Why haven't investors preferred direct plans?

Over last few years, almost all fund houses have managed to generate higher returns on assets of the same scheme coming through direct plans. However, the returns haven't been significantly greater than those produced by the regular plans.

Once you eliminate the broker or the agent, you forgo the facility of doorstep service that many middlemen offer which investors perhaps find inconvenient when they opt for direct plans. Additionally, the paperwork involved while investing in mutual fund investing discourages investors from opting direct plans.

Although this is unfortunate, retail investors seem to have ignored direct plans due to some initial cumbersome processes, especially those related to KYC (Know Your Customer).

Why should you prefer direct plans?

Direct plans offered by mutual funds make a positive difference to your investments every year. The direct plans generate roughly 0.5% to 1.0% additional returns every year. However, if you sow seeds of these small savings, you may harvest rich rewards over 15- 20 years - thanks to the power of compounding.

Direct Plans Are Effective Over the Long Term
Year Direct Plan Regular Plan (considering the difference of 0.75% in expense ratio) Regular Plan (considering the difference of 0.50% in expense ratio)
2016 100,000 100,000 100,000
2017 112,000 111,250 111,500
2018 125,440 123,766 124,323
2019 140,493 137,689 138,620
2020 157,352 153,179 154,561
2021 176,234 170,412 172,335
2022 197,382 189,583 192,154
2023 221,068 210,911 214,252
2024 247,596 234,639 238,891
2025 277,308 261,036 266,363
2026 310,585 290,402 296,995
2027 347,855 323,073 331,149
2028 389,598 359,418 369,231
2029 436,349 399,853 411,693
2030 488,711 444,836 459,037
2031 547,357 494,880 511,827
2032 613,039 550,554 570,687
2033 686,604 612,492 636,316
2034 768,997 681,397 709,492
2035 861,276 758,054 791,084
2036 964,629 843,336 882,058
For illustration purpose only
Net returns generated by an equity scheme in a direct plan are assumed to be @ 12% p.a.
(Source: PersonalFN Research)

The table above demonstrates how small savings of 0.75% or 0.50% in expense ratio for 20 years can make a huge difference, assuming the returns clocked are 12% compounded annualized. Let's make one more assumption-the regular plan of the same scheme changes 0.75% extra. Do you know the difference this would make over 20 years? Well, the difference would be worth Rs 1.21 lakh - which is higher than your initial investment. A little conservative estimate, considering the difference in the expense ratio would be just 0.5% every year, suggests that the excess money that you would make in 20 years' timeframe would be over Rs 85,000. Now investing in direct plans sounds promising; isn't it?

There's another benefit of investing through direct plans. You can easily avoid commission driven distributors and agents who often misguide you. You get a chance to do your research on available investment options.

But many investors find this job very tedious and time-consuming. If this has been your reason for not investing, it's time you re-examine. Many platforms offer you ready tools to compare funds just at a click and control of the mouse.

Alternatively, you can always seek help of an independent mutual fund advisor who offers an unbiased research-based view for a fee, and you're always free to invest in a direct plan. For your long-term financial wellbeing, it is essential that you review your portfolio so that corrective measures can be taken at the right time.

The time has come to ask yourself and judge: Are you compromising on long-term returns for a little comfort in the short-term by availing services of mutual fund distributors, or is there a real value.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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2 Responses to "Why You Should Opt For Direct Plans While Investing In Mutual Funds"

Sunil Bhagat

May 15, 2016

The role of a good distributor gives many benefits. Basically Equity MFs are long term products woven around goals and dreams of the investors. It is a long journey and investors generally do not have the time to pursue the direct investments on a continuous basis even though they may initially try to do so.
The costs may seem to be less in direct investments but the truth is that the mf company also incurs extra costs on its staff to canvas mfs.Overall only if an investor can do all this in the longer run or has the expertise to know asset allocation and his risk profile the only they should venture into the direct option.

Like 

RAJENDRA JAGTAP

May 6, 2016

JAGTAP
the article is good and informative but some more information is required
what is the percentage offered to the brokers for sip/stp/liquid/debt fund etc.

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