Direct Plan of Mutual Fund is creating lot of buzz in Personal Finance space. In last one month or so, i have gone through atleast dozen posts on Direct Plan of Mutual Funds. The advantage of Media coverage is that it create buzz. Investors are seriously considering Direct Plan of Mutual funds which currently contribute less than 10% of total investments (Industry Estimate). Currently this channel is utilized by Institutional investors or HNI’s and that too in debt category. Contrary to the fact that expense ratio of debt category is very low compared to equity. In my post on 7 Steps to Select Right Mutual Fund, i mentioned Expense Ratio as one of the key criterion to select Mutual Fund. The advantage of Direct Plan is low Expense Ratio compared to Regular plan. Reason being, you are buying the units directly from fund house. There are no intermediaries, brokers, agents or distributors. The fund house pass the portion of Direct Plan trail commission savings to investor. Before joining the bandwagon of Direct Plan, it is advisable to understand the pros and cons of investment through Direct Plan in Mutual Funds.
Why Direct Plan is Beneficial for Mutual Fund Houses?
For all mutual fund investments through agents / distributors, they receive trail commission from fund house. Though fund houses argue that these agents or distributors don’t add any value through their advice. The suggestion of a distributor is normally biased and based on Trail Commission received by them. Agents / Distributors intentionally sell or de-sell particular mutual fund schemes depending on trail commission. In short, mutual fund houses are not in control of last mile connectivity i.e. distribution channel. It impacts their business. Mutual Fund Scheme offering high trail commission are promoted heavily by the distributors for obvious reasons. It leads to mad race to offer high trail commission to distributors. Small fund houses offer high trail commission as they have nothing to lose which impact business of big fund houses. In order to retain business, big fund houses also offer trail commission to distributors to retain the business. Mutual Fund is a volume business with thin profitability. Any trail commission eats into profitability of a fund house. In other words, savings on trail commission can potentially increase the profitability of fund house.
How to solve this problem?
The best solution is to create PULL factor for Direct Plan of Mutual Funds. Now how to create PULL Factor. Very simple, create an impression in the mind of investor that returns from Direct plans are high compared to Regular Plan. In other words, Higher Returns compared to Regular Plan is the sole USP of Direct Plans. Any mutual fund investor must have come across colorful posts on internet and media shouting loud on benefits of investment through Direct Plan. Graphs and Bars showing incremental returns are hitting the stars and moons. Is it true or are we missing the bigger picture?. Now you must be wondering, if i am getting higher returns in Direct plan then what is the harm in investing through Direct Plan of Mutual Fund. Lets check out the real story
Why Retail Investor should Avoid Direct Plan of Mutual Fund?
Before making any investment, it is advisable to do cost benefit analysis. This analysis should be both quantitative and qualitative. Lets check key parameters which impact Direct Plan of Mutual Funds
Size of Portfolio
Incremental return is biggest PULL factor for direct plan but it is imp to check its impact in absolute terms. As i mentioned that difference between expense ratio of direct plan and regular plan is negligible in debt category. In equity segment also, the average annual difference in NAV is only 0.5%. Assuming i am investing in particular fund through monthly SIP of Rs 2000. In laymen terms, it will impact returns to the tune of Rs 10 per month in terms of absolute return. For a monthly SIP of Rs 10000, the impact is only Rs 50 / month. Annual impact will be Rs 600 on an investment of Rs 1.2 lakh. On the contrary if i select wrong Mutual Fund, the difference between worst and best performing mutual fund in Equity-Large cap is whooping 48%. Return of best performing large cap equity mutual fund is 66%. Return of worst performing fund is 18%. Rather then wasting time to find out how to get incremental 0.5% return by selecting Direct Plan, i should invest time in identifying good mutual fund. It makes sense for large portfolio size of say 1 Cr to invest through Direct Plan. Absolute impact will be Rs 50000 every year. For retailer investor, 0.5% return will come with all kind of limitations and hassles as discussed in following points
Records of Investment
It was quite shocking for me that none of the financial planners touch upon this point in their post on Direct Plans. Today if i invest in 8-10 mutual fund schemes of 5 fund houses then i need to remember and store details of all the direct schemes separately. If god forbids and some thing happens to me then my wife has to search & trace all the details. We forgot one imp point that approx 22000 Cr investors wealth is lying unclaimed in various financial instruments. The only reason is either the investor forgot about investment or legal heirs of investor could not trace any record of the investment.
The basic thumb rule of personal finance says that all the investments should be consolidated, concentrated and preferably centralized. If i have single unified mutual fund account with bank or distributor then my wife can easily access all the details through single window. Remembering password of 10 different accounts is a big hassle.
Now you must be wondering what about single consolidated statement generated by CAMS etc. for all mutual investments. Answer is that you cannot rely on same. The day i registered my email id, i stopped receiving physical statement. My wife may not have access to my Email account.
Life should be clutter free and investments should be kept as simple as we can.
Documentation
Documentation is major hassle in direct plan for both online and offline investors. For each investment, you have to complete separate set of documentation. If you are active investor then its a nightmare. Today, i have mutual fund account with one of the leading private banks. I can place order / redeem mutual fund units with 2 mins flat without any additional documentation for each investment.
Operational Hassle
For investors who are not comfortable with online operation, it will be operational nightmare. For every transaction they have to visit the branch of fund house. In case of agents / distributors, they provide pick up service to regular investors. Also the agents / distributors have wide network of branches compared to branches of a fund house. In a city, you will find 1 branch of fund house but there will be 10-15 branches of popular agents/distributors.
Investment Advice
Though i agree that agents / distributors do provide biased opinion when it comes to selection of mutual fund. But i observed that not everyone does that. Secondly they explain basics of mutual funds which is imp. The trend is now changing. To retain investors distributors are not that manipulative as they were 6-7 years back. If investor will not gain from his advice then he will switch loyalties very soon. Under current regulatory framework, agents / distributors are struggling to survive and they don’t want to kill their business. For the first time mutual fund investor this basic education is required which is missing in direct plans.
A Big Hassle
Considering all the above mentioned points, Direct Plan of Mutual Fund is a BIG HASSLE at macro level. If you are active investor and rejig / churn your portfolio at regular intervals then its a major hassle. Even for small investors, it is advisable to evaluate performance of mutual fund every 6 months. Under direct plan of mutual fund, it will be nightmare. Direct Plan is beneficial for HNI’s or Institutional investors with large portfolio. From retail investor point of view, it is advisable to opt for online facility from your distributor preferably bank and invest in mutual funds with peace of mind. It is imp to select right mutual fund scheme and keep track of its performance for maximum returns.
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I am sorry but I have to say that this article is written by someone who seems to be an apologist for the distributor community which is bound to lose income when people migrate to direct plans. The author is trying to make a point that direct plans should be avoided as they may not have a real benefit for the investor and because these are being pushed by mutual fund houses because it benefits them.
I think the fallacious arguments made in this article should be exposed so that this article does not mislead the general public.
1. Direct plans are beneficial for mutual fund houses: The author is right and it helps a lot of fund houses financially if they can avoid paying distributor commission and retain their margin. The author does not tell us who stands to lose. If investor and the mutual fund do not stand to lose its the distributor and it seems that the author seems to make a case for the distributors in this article.
2. Mutual funds are creating a pull factor for their benefit and investors need to carefully evaluate if direct plans are beneficial. The point is valid, however the author fails to appropriately highlight the advantages of the direct plans to investors and plays them down cunningly and highlights some flimsy negatives to portray that direct plans may not be beneficial. Now let us examine how.
ARGUMENT 1: SIZE OF THE PORTFOLIO:
The impact on returns from investing in a direct plan can be approximately 0.5% (compounded basis). Author says for small ticket size of e.g. 1 lakh it means losing out on 500 Rs. which is a negligible amount. However, he does not say that this 0.5% is a recurring charge till the tenor of investment which means that in a 5 year period this charge will be Rs 3,000 + depending on the returns (on a cumulative basis).
Not a Big number? OK …….If given a chance to invest in a fixed deposit of a bank a person is told that you will get 7.5% returns and 7.0% returns for a 5 year period which one should one chose.?
This is still not the BIGGEST FLAW IN THE ARGUMENT. THE BIGGEST DOWNSIDE IS THE LOSS OF EXCESS RETURNS… let me explain it in detail.
Institutional and large investors typically invest in debt and directly and they are not common people like you and me. Retail investors typically participate in equities where there is more risk and higher returns as well. The rationale for putting money with a fund house and paying them a fund management fee is that the fund manager will generate excess returns over and above the benchmark returns. Typically large diversified equity schemes will on an average give 3-5% excess returns over sensex for a 5-10 year period. Now if you consider excess returns after shaving off 0.5% (for not chosing a direct plan) you are sacrificing anywhere between 10-20% of the excess returns (i.e. 0.5% of 3-5%) that you could have made which is a very big opportunity loss for through a intermediary.
For a portfolio of ~50 lakhs market value, would someone be willing to spend annually 25,000 rs (0.5% of the value for not chosing direct plan) to pay his intermediary for no advice..? The author himself states that distributors are interested in their commissions and hence sell the products that benefit them and hence to what extent can one rely on a distributor.?
DIRECT PLANS MAKE IMMENSE SENSE FOR SOMEONE WHO CAN CONFIDENTLY CHOSE THE RIGHT FUND. for those who can’t it still makes sense because you will not always invest in the worst performing fund (as author wants to scare you by projecting the difference between the worst and the best scheme), There is lots of free advice on internet and one can refer to sites like moneycontrol, value research, morningstar etc. to select rated funds….and one will invariable be able to invest in better funds over a period of time even if one selects the rated funds.
The underlying rationale is that no pains without gains…and one has to “learn and practice” investing. For those who want to be passive and rely on others…..they can continue through distributors who will make money at their expense.
ARGUMENT 2: DOCUMENTATION
Author did not tell you that there are apps from CAMS and KARVY which allow you to track your folio on mobile or on internet. It helps you keep a track of your all investments in funds and can help you getting account statements and getting your basic process requests executed.? And all of this is in one place and not hassle free….. definitely not more clumiser than maintaining a set of savings and fixed deposit accounts. All one has to do is the initial set of KYC to begin investing and the investment process is then seamless across funds if investing online. “Some pains for some gains” are warranted and you will not pay a bomb to get odd jobs done through a distributor. With common folio number initiatives being rolled out things are set out to be simpler in future.
ARGUMENT 3: OPERATIONAL HASSLE
This has some merit for those who do not invest online or are not comfortable online. For them they will have to see the costs that they are paying for getting so-called operational services like fetching and submitting of physical documents. I would love to be in a distributors shoe who manages and AUM of a lazy HNI client (50 lakhs apprx) and get a recurring commission of anywhere between 25,000 – 40,000 just to manage some odd chores of getting the documents collected and submitted.
ARGUMENT 4: INVESTOR ADVICE
If the author believes that advisors provide good advice they should not have any qualms on moving to a model where they get advisory fee directly from the customer rather than indirectly from the fund house. That will be more fair for the system because an adviser will get what he gives as a service to the customer. But unfortunately the cartel of distributors don’t want to give up the opportunity to give up easy income. There were news reports that mutual funds are not able to push direct plans fearing a backlash from distributors. Except for Axis and SBI no other fund house have been able to utilise their own channels effectively and this includes the biggies like HDFC and ICICI. Does the author believe that selecting a right advisor is an easier problem to solve than selecting a right mutual fund scheme.?
ARGUMENT 5: BIG HASSLE
Can author substantiate why tracking of performance of indirect plans is not a hassle if direct plans are a hassle.? How is tracking of a indirect plan not a “nightmare” even if someone does significantly high number of transactions.? The intermediaries who provide facilities to track all investments in one place are no better than the information provided by CAMS and KARVY which lists all the transactions , holding period and the IRR and also provides the links to NAV’s free of cost. These services will improve with a period of time.
Thanks for sharing your views. Just to clarify that i am not associated with any community or financial institution. The views shared by me are my personal views. I am glad that we both agree on almost all the points shared by me but have difference of opinion on the conclusion :)
Thanks again and hope readers will be benefited from your point of view.
I really enjoyed this healthy difference of opinion.
Hi,
I am layman in this(Investment in MF) and out of curiosity searched on google”whether to invest directly in MF or indirectly(regular plan)”.I got this link and author’s points were all looked valid in article.Until i saw your post.
Now i got confused…as i agree with all your counter points.
But please tell me is it ok for investor(beginner) like us to start off with regular plan?as and when i get more info on this i would move to direct plan.
Please let me know your view on this.
Sir, investing in Indirect plans will make sense for you, if you absolutely do not have the confidence of understanding some mutual fund investment and selection basics. Also if you are hard pressed for time and cant spend time in basic analysis and research of Mutual Fund investments and geting some basic KYC paperwork done then also you can go for the indirect plans.
In case the quantum of intended investment is high (e.g. 50 Lakh Rs) be prepared to lose 20-25K p.a. in terms of lost returns because of chosing a indirect scheme. As a thumb rule for every 1 lakh invested, you will typically lose out on returns of Rs 400-500 Rs p.a.
It may not be too daunting to learn the basics of investing and there is plenty of literature available. I would suggest you to define the investment objective first, and select an appropriate fund. Websites like valueresearch, moeycontrol and morningstar rate mutual fund schemes and go for the highest rated funds and you wont go horribly wrong.
does the fund house give trailing commissions every year or only for one year? i am trying to understand the loss stated of Rs 400-500 pa for each lakh invested will be recurring or only for first couple of years. for example i invest Rs 1,00,000 in regular plan instead of direct, will i loose rs 500 every year till i redeem? also is the approximate loss same for equity as well as debt funds or they are different ?
The commission is only at the time of purchase.
As a matter of fact, in regular plans, the commission is paid every year as a trail. In some funds and to some distributors there is also a one time upfront commission at the time of purchase.
The drawback with direct plans was that we had to approach each AMC in online or offline mode to invest in direct plans. Subsequently, MF Utility came into picture and you could transact in direct plans of multiple MF schemes from a single interface online and consolidated investments can be tracked through the mobile app.
MF Utility (MFU) is an initiative by Association of Mutual Funds in India (AMFI). MF Utility is owned by MF Utilities India Pvt. Ltd, which is equally owned by 25 participating asset management companies (mutual fund houses). All the major mutual fund houses are participants in MF Utility. MF Utility offers a transaction interface to both MF distributors and investors. All you need to do is register for CAN by filling in CAN registration form. CAN stands for Common Account Nummber, a unique identifier issued by MFU.
I would say MFU is a boon for direct investors and it depends on individual if he is good with a regular or direct plan.
Absolutely agree with viewpoint. but what about buying direct and transferring in to my Demat?
Sorry, i could not understand how will you do. If you buy through 3rd party platform in your demat account then it is not direct purchase.
I don’t agree at all. Direct plans are way better .. but for the ones who are educated enough to understand the mutual funds and are disciplined enough to maintain different passwords. I have been using direct plan mode and never faced any issue.
totally wrong advice. There are utilities like MFUtilities, Invetza. In fact you can easily track all your ‘direct’ mutual funds in valueresearchonline and all your passwords across various funds can be saved in google password manager. In order to safeguard your google account, go for two factor authentication.
There is no problem with tracking 8 or 10 funds, only thing is they will not be offering much diversification, so sticking to five funds is fine.
You can study about funds and investing from various articles on the internet like morningstar, valueresearch, investopedia etc.
It is your own hard-earned money, so take the time to learn about investment, direct mutual funds etc. And also take time and learn to invest online. In fact even term insurance should taken online. You end up saving a lot of money. This is how rich people become rich, they know how to save on costs. That is apart from being born rich.