Should you invest through direct plans in mutual funds?

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Clik here to view.From 1 January 2013, SEBI is allowing investors to invest through direct plans in mutual funds. I will simplify some of the questions that might arise in your mind regarding direct plans in this article.

Question – I used to invest directly without a distributor. What is different now?

Answer – Earlier SEBI chief Damodaran had allowed waiver of entry load on mutual funds if an investor approached the fund house directly instead of going through an agent/distributor. This meant a good saving of 2-2.5% of your investment. Later, entry loads themselves were scrapped. This meant that there was no difference between going to a distributor or going directly to a fund-house to make an investment into a mutual fund. The expense ratio were anyway the same.

Mutual fund Asset Management Companies (AMC) pay commissions to distributors for bringing in business. If I approach the AMC directly, the AMC is actually getting my business without any distributor expense.

Direct investors mean lesser cost for the AMC. They are now being asked to separately allocate expenses to the direct plans and regular applications brought to the AMC by a distributor. The latest move by SEBI means that fund houses will have to start having two classes of Net Asset Value (NAV) for a given scheme. Direct plan NAVs should be higher than the regular plan NAVs for the same fund performance.

Lower expenses on direct plans in mutual funds can mean a big difference in returns in the long-term. This is a positive step for retail investors. See a past article at Capital Orbit that explains impact of expense ratios on mutual fund performance.

Question – I already have invested through an agent or distributor? Should I exit the investment? Should I re-invest the same amount in a direct plan for the same mutual fund scheme?

First, you still have to grapple with exit loads. Recently, in what looks to be anti-investor behaviour, many AMCs have increased exit loads. You will take a hit if you exit. This might be more than what you end up saving in the direct plan with lower expenses in the future.

You need to worry about tax. Short-term and long-term capital gains have to be considered. If you prematurely rush to break your equity mutual fund investment before 1 year, you could face short-term capital gains tax of 15%. Alternatively, if you were otherwise going to hold it anyway, you would have zero long-term capital gains tax after 1 year.

Question – For fresh mutual fund investments should I go for direct plans?

Direct plans will tend to have lower expenses than regular plans. In the long-term this will boost your returns as compared to regular plans.

Overall, mutual fund selection is not difficult. Go to sites like Moneycontrol or ValueResearch to pick good funds. Go for long-term data in case of equity mutual funds. A 3 year and 5 year performance is good to evaluate. See if it has performed relatively well in market down-cycles.

Before going for a direct plan investment you need to ask yourself whether you are comfortable in choosing the right mutual fund. If yes, then do so. If no, then you are better off working with your financial advisor, taking his or her advice and going for a regular plan.

Recommended reading

CAMS has created a good FAQ on direct plans in mutual funds. Click here to access the Google Docs document.

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