Invest in direct mutual funds for higher returns
Invest in Direct Mutual Funds For Higher Returns
All mutual funds have two plans – Regular and Direct. Direct plans give higher returns every year because investors do not have to pay commissions. Despite this, nearly 90% of retail investors invest in Regular plan mainly due to lack of awareness. Investors can now transact in Direct plans through platforms such as ORO.
What are direct plans in Mutual funds?
In 2013, SEBI announced that every mutual funds cheme will need to have two plans. One would be the regular plan which had existed till date. In addition, mutual funds had to introduce a direct plan of the same scheme which would be similar to the regular plan in all respects but would have a lower expense ratio (i.e. fees you pay the mutual fund). This is because when you invest in the direct plan, there is no distributor involved and the commissions that mutual funds have to pay distributors go away.
Paying lower fees on exactly the same fund directly translates into higher returns for investors. The difference between the expense ratio of regular and direct plans can be as high as 2% for some mutual funds (Figure 1). On an average, direct plans are 0.66% cheaper than the corresponding regular plans – that is a discount of nearly 40%! (Figure 2)
Figure 1: Direct and Regular expense ratios for a selection of mutual funds.
|Mutual Fund Scheme||Expense ratio of direct plan||Expense ratio of regular plan||Difference between regular and direct plan||Discount on the direct plan|
|Indiabulls Blue Chip Fund||0.22%||2.47%||2.25||91%|
|Taurus Bonanza Fund||0.66%||2.7%||2.04||76%|
|Franklin India Multi - Asset Solution Fund||0.1%||1.90%||1.80||95%|
|ICICI Prudential Balanced Advantage Fund||0.63%||2.24%||1.61||72%|
|HDFC Small and Mid Cap Fund||1.23%||2.48%||1.25||50%|
Figure 2: Direct plans are a cheaper way of accessing exactly the same mutual fund
Does the difference in expense ratio matter?
A difference of 1-2% in returns may not seem much at first glance. However this extra amount is being paid to the distributor every year. When combined with the power of compounding, paying commissions can put a big hole into your final earnings. How big, you can check by using the interactive graphic on our homepage: www.orowealth.com
As an example, suppose you had invested Rs. 10 lakhs at the beginning of the period in a fund in which the direct plan has an expense ratio of 1% and the regular plan has an expense ratio of 2%. Further assume that the fund earns a conservative return of 10% before costs. Then at the end of 10 years, difference in your earnings between the two plans will be Rs. 2.1 lakhs. or more than one-fifth of your initial investment corpus. After 20 years, with the compounding, the difference will be a massive Rs. 9.5 lakh or nearly your entire initial investment corpus!
Table 1: Small gains can add up to big returns in the long term
|Year||Growth in investment with direct plan||Growth in investment with regular plan||Extra earnings with the direct plan|
|Initial Investment amount||10,00,000||10,00,000|
|Returns||10% - 1% = 9%||10% - 2% = 8%|
|Year 1||=10,00,000*(1+9%)= 10,90,000||=10,00,000*(1+8%)= 10,80,000||10,000|
Now you may not be invested in the same fund for that long but as long as you plan to be a mutual fund investor for some time, these numbers can’t be ignored. This can be gauged from the fact that the smart money investors in India (i.e. large institutions, corporates and similar professional investors) have already migrated almost completely to direct investing. After just 2 years of introduction, 70% of smart money investments happen in direct plans.
Maybe I am already buying direct plans?
Unlikely. Only 10% retail investors have invested through direct plans. There are a number of reasons for this. First and foremost is the lack of awareness among retail investors about direct plans. This has to do in large part with the fact that the distributors, who are closest to investors, have no incentive to promote direct plans. In fact many of them market their services as “free” to the client, conveniently overlooking the fact that they get paid every year from the investor’s money, even though it is via the mutual fund.
A second reason is that so far it has been difficult for retail investors to invest in direct plans. The main way of doing this has been by maintaining separate accounts with each mutual fund company which is cumbersome.
Finally many retail investors are also scared away from direct investing by distributors and platforms which claim to offer expert advice that investors will miss out on if they go direct. Professional financial advice is important and can make a big difference to returns but the important question to ask is – Is commission-based model the best way to get investment advice? Mis-selling i.e. selling investors the highest commission products is the biggest flaw with this model. The second question is whether that advice should actually cost 2% per year. Instead by going direct, investors can use just a part of the saved commissions to hire an unbiased, fee-based advisor whose incentives will be aligned with their own.