Updated on: April 29, 2021 ; Investments
What are mutual fund direct plans?
You can invest in any mutual fund in India under two different plans. Mutual Fund Regular Plan and Mutual Fund Direct Plan. I aim to emphasize the benefits of the mutual fund direct plan in this article. But before we get there, let me briefly explain how is it different from a regular plan.
In mutual fund direct plans, an investor can invest the money in the mutual fund scheme without involving any agent or distributor in between. In the case of a regular plan, there is always an intermediary distributor or agent involved.
Any mutual fund scheme will have a direct as well as a regular plan. Both the plans under the same scheme will have the same portfolio, same investment style, same asset allocation strategy, and same fund managers.
But since the distributor/agent has been eliminated in the direct plan, you save on the commission paid to the distributor/agent. The investor gets this benefit directly, which translates to higher returns in direct plans than its ‘regular’ counterpart.
We will revisit this cost differential a little later. For now, let’s understand when did the mutual fund direct plans start.
The inception of mutual fund direct plans:
The mutual fund industry dates back to 1967 in India. In the initial years, there were very few players in this industry. UTI (Unit Trust of India) and a handful of PSU managed fund houses dominated this space for the first few decades. This sector opened up for private players later in 1993. That was a very short history of mutual funds in India.
Before 2013 all the mutual fund schemes in India were regular plans. Then Securities and Exchange Board of India (SEBI) introduced the direct plans for mutual funds in January 2013. After that, all the mutual fund providers had to provide a direct plan option for all their schemes mandatorily.
Direct vs Regular plan:
The only difference between the two plans is the involvement of a distributor.
The distributor charges a commission fee in a regular plan. If you opt for a regular plan, you will have to pay this commission till the time you stay invested. It is not a one-time fee that you pay only at the time of purchase.
So you not only pay this additional cost in a regular plan, at the time of purchase in a mutual fund. You have to pay this fee throughout the entire investment period.
The direct plan has no distributor or agent involved. This results in a lower cost for the direct plan investors. Now, each mutual fund incurs annual operating expenses. These include the advertising cost, fund management charges, commission paid to the distributor, and other costs. The mutual fund then adjusts these expenses in the fund’s daily net asset value (NAV). These costs as a proportion of the daily net assets are called the Expense Ratio.
So, the absence of commission fees in the direct plan translates to a lower expense ratio. This results in higher returns for the direct plan. The NAVs also differs between the two plans. Direct plans have a higher NAV than regular plans.
This difference in expense ratio varies from scheme to scheme. The fund house revises these values regularly. This difference is around 1% for equity mutual funds. This might not seem to be a very big difference. So why bother going for a direct plan?
Wouldn’t it be better to stick with the regular plan where you have an agent who will guide you with your investment strategy and take care of all the operational aspects of buying mutual funds? And the agent charges ~1% only as a commission for these services.
Let’s look at a few long-term scenarios before you pass the verdict.
How high is higher?
We mentioned that the returns of a mutual fund direct plan are higher than its regular sibling. But do we know how much of a difference would it make to your investment portfolio?
We will look at a few numbers to answer this question. The following table illustrates a hypothetical scenario where our investor invests 100,000 rupees as a one-time investment for 30 years. He doesn’t touch the money for 30 years. In one case the investor invests the money in a regular plan and in the other case he/she invests the money in a direct plan.
The regular plan gives an annual return of 8.5%. The difference in the expense ratio is assumed to be a conservative 0.6%. That makes the annual return of the direct plan to be 9.1%.
This difference of 0.6% is at the lower end of the prevailing market rates. We start with this rate to see what are the minimal benefits of a direct plan. We will also take a look at the impact of higher differences later in this article.
The table above shows the investment values of 100,000 rupees seed investment at 5 years intervals.
You would have noticed that the difference in the investment value between regular and direct plan grows substantially as time passes. This is because the small difference of 0.6% applies every year. When this difference compounds over 30 years, that is when you see the actual impact it creates.
Even with a conservative difference of 0.6% in expense ratios, the direct plan earns 113,629 rupees more than the regular plan in the first 25 years. This difference itself exceeds the initial investment amount. Percentage-wise you earn ~15% more than the regular plan. This is not a small or an ignorable difference.
So, where does this difference in earnings go in the regular plan? It goes to the agent/distributor as his/her commission.
Now, take a closer look at what happens in the last 5 years. While it takes 25 years for the difference to cross the 100,000 mark, it just takes another 5 years to cross the 200,000 mark.
At the end of 30 years, the mutual fund direct plan earns you 207,949 rupees extra. This is 18% more compared to the regular plan.
Now, time to look at an example that is closer to real life. We will now consider the case where the difference in expense ratio is 1%. This is the case for many mutual fund schemes.
Here, the regular plan returns remain the same as the last case – 8.5%. Because of the 1% difference in expense ratio, the returns for the direct plan becomes 9.5%.
You can see from the table that the direct plan earns an additional 100,000 rupees in the 20th year itself. This is 20.1% more than the regular plan. This difference grows to almost 200,000 in 25 years, which is ~26% more than the regular plan. After 30 years, this gain grows to 366,206, a whopping 31.7% higher than its sibling.
Draw the comparison between the two tables and see what a small difference of 0.4% can do to your investment value.
You have to remember that this difference between the regular and direct plan for mutual funds will differ from scheme to scheme and from time to time. So, I have summarized the difference in returns for different scenarios in the table below.
You can see how substantially the investment value increases with a small change in the expense ratio.
Now that you have understood the benefits of direct plans, you would want to know how to buy them.
How to buy Direct Mutual Funds?
The easiest way is to go to the respective Mutual fund or Asset Management Company’s (AMC) office or website. Get yourself registered, and make your purchase. If you are an existing customer with the AMC, then the process becomes even simpler. In case you are a new customer for the AMC, then you would need to provide the necessary documents for KYC. This would include your PAN card, address proof documents, bank details etc.
The easiest way to do this is online. You won’t even have to step out of your house as everything can be done online now.
In addition to the above, there are other service providers like some discount brokerage houses and fintech Apps that provide this facility for free or charge a very reasonable amount. They also act as a convenient place for investors to compare schemes from different AMCs in one place.
You can also make purchases on registrars’ website or Apps like Karvy and CAMS.
The expense ratios will be the same for a particular mutual fund scheme irrespective of where you buy your mutual fund from. The seller may charge a separate fee for their services, so please check for such charges before you make any transaction.
Now, these were a few easy and convenient ways to invest in direct plans. There would be other ways as well. But I think you might not need to look beyond these options. Still, please do your research before choosing, as with time, there may emerge better options.
Final remarks:
There is definitely big merit in opting for direct plans. But someone might prefer to take the services of an agent. If the agent provides good financial advisory services and takes care of balancing your portfolio regularly, then it might make sense to choose regular plans. In that case, the commission earned on the mutual fund scheme will go towards paying the agent’s fee.
You can also opt for direct plans and avail of the services of an investment advisor separately. The fee structure would have to be negotiated with the advisor/agent independently.
As a prudent practice, it is always advisable to take the advice of an expert in financial matters. The right advisor will choose the right financial strategy for you. Most likely, the advisor will recommend a few mutual funds in your portfolio. Do ask him/her to invest in direct plans and listen to what he/she has to say about it. This will help you assess him/her on his/her honesty and openness.
When it comes to mutual fund, Think Direct !!!