Direct plans of mutual funds: Should you switch just because of the lower cost?
It’s 10 years since direct plans for mutual funds were first introduced. These allow investors to buy schemes directly from the AMC at a much lower cost than what they would have incurred had they bought through a distributor. But will you benefit if you make the switch? The utility of direct plans, as envisioned by the market regulator, is straightforward. It allows the investor to buy directly from a fund house, and shave off the cost associated with going via a distributor. Direct plans have the same underlying portfolio as the regular plan. Only the NAV is different because of lower expense ratio. While the average regular plan charges 2.1% annually, its direct plan counterpart levies around 1%.The difference stretches to 1.6% annually in a few cases. Saving on the distribution fee results in higher return for the direct investor over time. With 10 years’ track record now available, it is evident how big a difference direct plans have made. The regular plan of the average flexi cap equity fund has fetched 13.16% annualized return, even as its direct plan variant has clocked 14.08%. If you had accumulated Rs.5 lakh in Kotak Flexi Cap Fund’s regular plan 10 years ago, it would have grown to Rs.20.55 lakh today. The same investment if shifted to its direct plan 10 years ago would have grown to Rs.22.65 lakh—fetching Rs.2.1 lakh more.
This is a telling difference. As the time horizon expands further, it is a mathematical certainty that this differential can only grow. For anyone still taking the regular plan route, this widening chasm will seem revolting. It may even nudge some to make that shift to the direct plan. Indeed, for investors pursuing actively managed strategies, this move seems like a no-brainer. Vidya Bala, Head – Research, Primeinvestor.in, observes, “With the margin of outperformance of funds thinning, expense ratios will further eat into your returns. And doing the regular plan route – offered by banks, distributors – will not help, as the additional cost (commission) will make it more difficult for your investments to beat the benchmark.” But a bulk of retail money is still sloshing around in regular plans. According to AMFI, as of November 2022, 19% of retail assets are in direct plans. The rest continues to be routed via intermediaries.
While the needle is inching towards direct, it is happening at a modest pace. This is despite multiple platforms catering to DIY investors, offering zero-cost access to direct plans. These afford convenience in onboarding and exit, user-friendly tools to sift through funds under one roof, and more. Direct plans are at your fingertips. Yet, there is no rush to cross that divide. There are some practical issues. Any such switch is treated like a redemption for taxation purpose. It can put immediate tax burden on the investor as any capital gains realized from this transaction are taxable. Simply staying put in the regular plan will let you defer tax liability for later. Second, porting the investments out of regular into direct may seem like a hassle for some. To be sure, there are easy solutions—service providers like CAMS and KFintech facilitate this switch online and some of the direct-only investment portals allow you to upload your existing portfolio and initiate the switch to direct.
Lower expense ratio has meant higher returns for direct investors
The reality is, many are not yet ready to make that jump. Fintech platforms have popularized DIY investing but much of this money is not backed by the right mindset. Investment choices are often guided by recent performance charts, ignoring risk. This return chasing leads to unhealthy accumulation of schemes, with no clear direction. Money is spread thin over multiple funds, diluting wealth creation. “Investing is different from buying groceries or clothes or what not,” notes Bala. “The quality of the product and its suitability should determine whether you should invest. Most large platforms do not provide this service or provide very little of it – leaving you with myriad options.”
Beyond this, however, one cannot overlook the behavioral aspect. Surrounded by all sorts of noise, lay investors on the DIY path are prone to act erratically. Stopping and restarting investments to outsmart the market only ends up leaving a gap with the market or fund return. Here, the intangible value added by handholding from a good adviser can be immense. Apart from helping identify suitable funds, the right professional can help you steer clear of your emotions and biases. The saving from avoiding costly mistakes can be higher than what you expect to gain from switching to the direct plan. Mrin Agarwal, Director, Finsafe India, insists, “There is a lot to sound financial advice that cannot be captured in mere numbers.”
Clearly, the decision to shift to direct plans should not be taken in haste. The prospect of saving a few lakh rupees in costs may seem enticing, but the lower cost of a direct plan should not be the sole motivation for the switch. “Nowadays there is so much focus on the fees. Everybody wants it cheap. But that cannot be the only criterion,” exhorts Agarwal. Only if you are confident in your ability to manoeuvre your portfolio and keep a level head should you consider venturing out on your own. There is no point switching to the direct plan if the chosen funds turn out duds, or if you cannot put in sufficient sums or stay invested through market upheavals.
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This story originally appeared on: India Times - Author:Faqs of Insurances
