Should a new investor invest in direct plans of mutual funds?
If you are a new and inexperienced investor, here are the key things to know before you take the plunge.
In the five-plus years since the mutual funds regulator forced all funds to offer a direct-to-the-customer option, most well-informed investors have understood the advantage of direct plans.
They know by now that all funds have a ‘direct from the manufacturer’ model, whereby investors can get a ‘direct’ equivalent of each scheme. These are cheaper too, as the fund house deducts lower expenses as it does not have to pay the ‘retailer’.
Thus, cheaper translates to higher returns. How much higher are the returns from direct funds? A small amount annually, but with compounding over the years, it builds up. So does that mean that direct funds should be an automatic choice for all investors? Not quite. The 1% or so per year differential of returns that exists between direct and regular plans is money, but perhaps not too much of it.
One could think of it as the money paid for the services of the distributor because that’s exactly what it is. The knee-jerk reaction of always going for the cheapest option would not serve many investors well, except for knowledgeable do-it-yourselfers. Whatever a mutual fund does for you is paid for by money that is deducted from your investments.
For equity funds, fund companies can charge in slabs that go from a maximum of 2.5% to a minimum of 1.75%. There’s also GST and all of this put together can raise the high point of expenses to just short of 3%. While the rate is expressed on annual basis, the money is deducted every day in small amounts so that the annual charge adds up to the full amount. This money goes to the fund company, with some of it eventually going to the fund distributor who sold you the fund.
While it is certainly arguable that mutual funds charge too much, the deduction is equal for all investors in a given mutual fund.
To understand the choice between direct and regular investment, let’s first see what the ideal role of an adviser could be. In a list created by an old American financial company, here’s what an adviser should be doing: Trust or credibility development; goal planning, portfolio construction, portfolio rebalancing, ongoing goal planning and risk adjusting, and just as important as anything else, being a counselor when the market is going down. Even though that sounds like a tall order, most investors need some subset of these services. Beginner investors also need simple convenience services to facilitate the transactions.
Even more than that, beginner investors need someone to get them started. Unlike a fixed deposit in a bank, a mutual fund investment is not simply an automatic extension of some services you are already getting. Being too focussed on the last sliver of cost may mean that you never actually get started.
Based on all this, what kind of an investor would be suited for direct investments? That would have to be someone who understands what kind of mutual funds are needed for different kinds of investment needs, is capable of researching these independently and come up with a list of funds to invest in, and then go through the process of actually investing without the help of an intermediary. After one starts investing, whenever the markets fall and investment values come under pressure, an external source of advice can help one stay the course. Essentially, do for yourself everything that an adviser is supposed to do.
Does this sound like you? If it does, then you could definitely earn some extra returns by investing directly. But if you are anything resembling a new and inexperienced investor, then you may be better off with a regular plan. Of course, this leads one to the question of whether it’s easy at all to find the right kind of adviser, but that’s a different story altogether.
(The author is CEO, Value Research)