As direct plans do not incur distribution expenses, the savings made in total operating expenses remain invested with the fund, which then start generating returns.
Increased financial literacy and easy access to market information has encouraged many retail investors to make their own investment decisions. Technological advancements and proliferation of online investment portals have enabled investors to buy, sell and avail other mutual fund services without requiring any human interface.
However, such DIY (Do-it-Yourself) investors are largely forced to pay for the distributor services they never required. Keeping in mind the interest of such investors, SEBI asked mutual fund houses to create ‘direct plans’ for all existing and new mutual fund schemes from January 1, 2013.
How do direct plans differ from regular plans?
Direct plans were created to enable investors to purchase them directly from mutual fund houses bypassing financial intermediaries. Those being bought and sold through intermediaries were categorised as ‘regular plans’. Both direct and regular plans of a mutual fund have the same investment objective, asset allocation strategy, investment style, fund management and portfolio composition. As with regular plans, in direct plans too you can choose between SIP, lumpsum and STP mode of investing as well as between growth and dividend options. They only differ in their NAVs and expense ratios.
Expense ratio: This ratio is the percentage of a fund’s average daily net assets used for meeting its annual operating expenses. Apart from fund management, administration, advertising expenses etc, operating expenses also include commissions paid to the intermediaries. As mutual fund houses do not incur distribution expenses in direct plans, such plans have lower operating expenses than regular plans. The lower expense ratio of direct plans translates into higher returns for investors. Generally, the expense ratios of direct plans are 1 percentage point lower than their regular counterparts.
Net Asset Value: The operating expenses of a fund are directly deducted from its net AUM. As direct plans have lower expense ratios, they deduct lower amounts from their net AUM. This leads them to register higher NAV. As time progress, the gap between their NAVs becomes larger.
Why direct plans generate higher returns than regular plans?
As direct plans do not incur distribution expenses, the savings made in total operating expenses remain invested with the fund, which then start generating returns. This leads them to register higher returns than their regular counterparts. Although the difference might seem trivial in the initial years, the power of compounding will make it substantial over the long term.
For example, assume that a 30-year old starts a monthly SIP of Rs 15,000 in the direct plan of a mutual fund scheme for his post-retirement corpus. If he continues with the SIP for 30 years and the plan generates an annualised return of 15%, he will have a corpus of Rs 10.38 crore. If the regular plan generates a 1% lower return than the direct counterpart, the same SIP would have grown to Rs 8.24 crore. The direct plan would outscore regular plan by whopping Rs 2.14 crore. As direct plans will always have lower expense ratios than their regular counterparts, they will always lead to greater wealth generation.
Where to buy direct plans from?Direct plans can be purchased from the mutual fund houses, either online or through their branch offices. However, this process can be quite cumbersome as you will have to apply with each fund houses separately. This may lead to duplication of paperwork or multiple IDs and passwords.
Alternatively, you can buy direct plans from independent financial advisors by paying an advisory fee. Since, you will pay this fee directly to your advisor; it won’t be deducted from your NAV.
However, some select online financial marketplaces are offering direct plans to investors for absolutely free, i.e. without charging any advisory fee, annual maintenance expenses or other charges. This has enabled DIY investors to manage all their direct mutual fund investments under one platform without paying extra for it.
Direct plans suit fresh investors too
Direct plans definitely suit DIY investors as they don’t require advisory services to make investment decisions. However, this has led to a wrong perception that direct plans are suitable for only experienced investors.
This argument may have been true till some time ago when direct plans could only be bought through the mutual fund houses, but today, with the emergence of online financial marketplaces investing in direct plans have become extremely simple.
Select online mutual fund platforms offer direct plans without charging a penny for it from investors and provide market insights, fund recommendations and online tools and calculators to help them choose their funds according to their financial goals, risk appetite, investment horizon, etc. They also offer free personalized advisory services to those who require greater attention.The writer is Director & Head of Mutual Funds of Paisabazaar.comNot sure which mutual funds to buy? Download moneycontrol transact app to get personalised investment recommendations.