Should We Switch To Direct Mutual Fund Plans? Calculate and Consider

Published: January 18, 2013 at 9:29 pm

Last Updated on

The answer is actually a no-brainer! Of course you should switch to the direct mutual fund plans. Need some convincing? Use a calculator and consider the the pros and cons …

Lets start at the very beginning  …

What is a ‘direct’ mutual fund plan? A MF purchased directly from an asset management company (AMC) from Jan. 1st 2013

What is a ‘regular’ mutual fund plan? A MF purchased through a distributor. All purchases made directly from the AMC before Jan 1st 2013 and all ongoing SIPs will be treated as ‘regular’ purchases

What is the difference between the two plans? In a regular plan, the AMC pays the distributor a loyalty fee known as trail commission each quarter. This is paid from the total assets under management and the NAV goes down proportional to the amount paid. In a direct plan this commission is not paid. Hence the NAV of the direct plan will be higher than the regular plan.

Note: Trail commissions are part of the expense ratio. (I earlier thought they were separate!) HDFC Top 200 direct plan has a 0.59% lower expense ratio than the regular plan as listed in their website (thanks to Anand for pointing this out).

Expense Ratio breakup

Say expense ratio is 2.5% or 250 basis points (bps). Here is a typical breakup:
100 bps goes to AMC fee (AMC pays upfront commission from this)
1 bps to trustees
10 bps to registrar and transfer agents
20 bps to operational expenses
3 bps custodians
80 bps distributor commissions
36 bps residual expenses (usually spent on end of the year advt!)
Large fund houses pay upfront commission from exit load corpus instead of AMC fee!

Source: Livemint article

Some history: In March 2012, months before the announcement from SEBI regarding direct plans, Anand Balakrishanan who blogs at Justgrowmymoney wrote about the impact of trail commission and how it affects direct investors. He even made a detailed spreadsheet to show how a trail commission of 0.15% each quarter can make a big difference and suggested ways to ensure direct investors don’t feel the pinch of the trail commission.  Kudos to Anand for highlighting this issue in his blog and in a conference of fund managers organized by Outlook Money.

Will the trail commission make a difference to returns? The short answer is Yes over a long period of time. Use this calculator/comparator to find estimate the difference in returns. Trail commissions are usually paid each quarter. For simplicity I have assumed this as an annual expense. The difference can be safely ignored as it is quite small (I checked with Anand’s meticulous spreadsheet which is no longer available).

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Download the Impact of MF Expense Ratio Calculator

Who should switch to direct MF plans? Anyone who cares about their money! Anyone who cares about their goals enough to choose investments after careful consideration.

Let us now ask an unpleasant question:

Who will not switch to direct plans? People who think filling up a form and applying to a mutual fund house in-person or even online is just too much work. Will you bet on such people to take care of their finances efficiently? Will you bet on such people to take informed decisions about the growth of their portfolio? Need I write it … Of course not!

Who should not switch to direct plans? Tempting to write people who don’t have make the time, have the patience, the inclination and therefore the knowledge to choose mutual funds, to rebalance their portfolio periodically etc. That would be too irresponsible and callous of me because if this lot does not manage their money who will for them? The distributors? Why should I bother with the answer to that question. Its their problem.

If that is not enough to convince you let us look at pros and cons of making the switch:

Pros: Higher returns of course. What is more important is a sense of control, responsibility and disciple in investing a switch can bring about in the retail investor willing to learn

Cons: None for a disciplined investor willing to continuously learn. For other kinds of investors … good luck to them!

Finally let us hear what Anand had to say about the switch in the Jagoinvestor Forum

The hurdles (to switching to direct plans) are listed as many but their impact is minimal:
1.Decide the investment category, plan, option on your own.
4.Track & rebalance your portfolio yurself.
– Independent distributors (including online ones) specify a particular portfolio of schemes based on risk capacity without taking into account individual circumstances. Thus they don’t help to track and rebalance either. Model portfolios based on risk taking capacity are available for free from several websites which can be used by individuals to invest directly.
2.Fill up investment form on your own
– One time activity. Any point in time you don’t need more than 4-5 schemes, so no big issues, IMO.
3.Visit RTA/AMC office to submit your forms for each redemption/ investment.
– Except a handful all of them are available for electronic redemption. Investment can be by ECS.

The advantages of Direct investing far outweigh investing through mediums for most people. Unless of course there is a distributor who can add individualized value-addition for investors

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