New investors often claim that the difference in expense ratios between regular and direct plans is not beyond 25 basis points. At the outset, this meagre looking 0.25 per cent may sound innocuous, but the same small gap bulges to a huge difference in returns outcome from investments continued for a decade or more. Imagine how the effect of the compounding effect of the expense ratio will eat into your returns in the long run.
It was around a decade ago when the Securities and Exchange Board of India (SEBI) assented to the concept of direct plans. The idea was to allow investors to put their money in various funds without seeking intermediate support from banks or financial institutions and in the process increase the prospect of returns at lower expenses.
With the direct plans completing a decade this January, it makes sense to how they have fared over the years and have benefited the investors. However, this must not prompt all investors to opt for direct plans, especially, those who are new to investing and need financial advice or handholding while dealing with their investments.
Direct plans differ from the regular ones
Mutual funds were always hold through an intermediary. It was like buying any product like clothes or groceries from retail stores. Mutual funds were sold through various agents like banks, financial advisors, stock brokers, big distributors with a national footprint, etc. Then SEBI announced that investors could buy directly from fund houses though there was no cost advantage. Investors suffered from this commercial disadvantage, which means that they did not gain by shifting from regular to direct or investing in funds directly from the asset management companies.
However, times have changed a lot since then. Direct plans cost less. This is because SEBI directed mutual fund houses to evaluate their direct plans’ expense ratios after deducting the commissions or charges they would have paid to their intermediaries to sell their products. Direct plans now cost much lower considering how some fund houses paid hefty charges to their intermediaries to boost their product sales. Apart, the fund houses were also asked to waive off the entry loads, an added expense that fund houses charged back then. The initial issue expenses of the open-ended funds were waived off before SEBI removed the charges on the closed-ended funds too.
Are direct plans worth considering?
If you know what funds suit best your portfolio or realize which funds would help achieve financial independence within the stipulated period, it would help a lot if you put your money in direct plans. However, you must not invest blindly in a direct plan just because the fund has become available. The investing process is easy, thus, explaining its rising popularity. However, investors have set the wrong expectations from some of these funds. Not that funds are inherently good or bad; it is just that not all funds befit your portfolio nor will guarantee you financial independence in time.
No doubt, the intermediaries have a role to play. They set the right expectations for the investors and then set the tone for investments. If you have access to all the information that brokers and intermediaries have, then do not hesitate to invest through systematic investment plans (SIPs) in direct funds. However, if you are finding it difficult to decide which fund to buy or do not have the temperament to invest in mutual funds and then stick to them, then by all means rely on what intermediary institutions say. They may have commercial biasness but it is still better than burning your money in investments not meant for you.
Direct plans are for investors willing to learn and build a positive temperament regarding market movement and how to stick to their investments, irrespective of the noise and chaos surrounding them. If you are confident about taking charge of your financial plan, go for a direct plan.
Moving your investment from a “Regular” to a “Direct” plan
Shifting from a regular plan to a direct plan is simple. There is a “Switch” request that you must make. However, this means that the money would be deducted from your regular plan and would be put into the direct plan within 24 hours. Though you can opt for the “Switch” implication from the fund company or the tax registrars, you must understand the tax implications of jumping from a regular to a direct plan too. Shifting from a regular to a direct plan would be deemed as “redemption” and subsequently a new purchase. The net result from this would be that all the gains that you had from the regular plans so far would be liable to capital gains tax.
However, all the capital gains accrued on your investments prior to 2018 is tax exempt. This means that the last four gains would be taxable though gains made before that would be subject to tax. Also, be careful about the “Exit Load” because if you are doing your SIP in the same fund, there would be an exit load applicable on your regular plan depending on the tenure of your investment. Be calculative about this exit load and then decide accordingly.
Have direct plans fuelled mutual fund investments?
Direct plans may be one of the reasons for higher inflows into mutual funds though it may not be the only reason for more people putting money in them. Other reasons for mutual fund investments may be more compelling, especially, for investors intending to earn more from these investments or those looking to earn returns beyond inflation. Also, awareness campaigns created by mutual fund houses sparked investors’ interest in them.
Bank interest rates are not too high, thus, prompting people to look for avenues that can help them earn more. The ease of investing has fuelled mutual fund investments unlike before considering how anyone with a bank account and online access can put money in these funds, be it through a lump sum or SIPs.
One cannot ignore the role of new generation fintech firms that have taken over the web and have helped people understand how they can put their money to work.
The launch of direct plans is very empowering as it helps well-informed investors to make their investment choices as opposed to relying on brokerage houses that sell products offering them maximum commissions. This way, they could take advantage of their decision of investing in a particular fund while availing of the cost advantage too. A SIP done for over two decades could lend direct plan investors a cost advantage of somewhere between 15 and 20 per cent.