Should you opt for the direct plan in mutual funds?

It's a fact vouched for by most buyers buying directly from the manufacturer by evicting the middleman gets you a better deal. Now, mutual fund investors will also be able to apply it in their lives. Starting January 2013, asset management companies (AMCs) will start rolling out direct plans for various schemes. Since no distributors or brokers will be involved in the transactions, these plans will do away with related costs.

Does this mean that investors will gain significantly by taking this route? Should you shift to the corresponding direct plan of a scheme that you are already invested in?

What's the advantage? 

Given that investors can currently buy units directly from an AMC, what's different about the new development? Today, if an investor deals directly with the fund company, the distributor's commission is pocketed by the fund house. Since it is not reflected in a lower expense structure, side-stepping the distributor does not translate into any gain for the investor.

Now, however, SEBI has directed the fund houses to offer separate direct plans, with distinct NAVs, to such investors. Since there will be no distribution and commission expenses, these will come with a lower expense ratio. Consequently, they will have a higher NAV and also yield slightly higher returns than the regular plans.

Industry insiders estimate that the yield could be 0.5-1.25% higher per year for direct plans, though this will vary among AMCs and various schemes. Since commissions are lower for debt schemes, the difference in expense ratio will be lower in case of debt funds. So, if a regular equity fund deducts about 2.5% as expense ratio annually, its corresponding direct plan could charge around 2%, or even less.

In the long run, this can accumulate to a significant amount (see graph). Dhirendra Kumar, CEO of Value Research, says, "Investors may not notice the variation initially, but the difference in return will start to show after a few years." Since investing in mutual funds has become costlier after the recent revision in cost structure, this will come as a relief for many investors.

 
What's the catch?

Don't rush to invest through a direct plan if your knowledge about mutual funds is not extensive. The do-it-yourself route will require you to go the extra mile to save the extra buck.

Currently, most people are accustomed to having their advisers or distributors handle investments on their behalf. In the absence of these, you will have to handle the homework, paperwork, even the legwork yourself.

The problem is that not many investors are comfortable with or savvy about identifying the right scheme to invest in. Most rely on professional advice. If you take the direct route, you will first have to devote time in picking the right scheme that is suitable for your risk appetite and return expectations. This is not an easy task even if you rely on past track record or fund ratings.

Pankaj Maalde, head, financial planning, Apnapaisa, says, "If you don't understand where and why you are investing, you may end up with a bad product." Of course, if you are already invested in a scheme and merely wish to switch to the direct plan of the same scheme, you will not face this problem.

Another issue that you are likely to face is that you will have to handle the documentation yourself. If you are investing in a fund house for the first time, you will have to download the application form from the AMC's website, fill it up and submit it, along with the accompanying documents, to the fund house.

Your subsequent purchases and redemptions can be done online. If you have been a laggard regarding your KYC formalities, you'll have to visit the nearest branch office of the AMC since updating KYC information requires in-person verification, unless you hire a distributor to do this for you.

Besides this, the onus of monitoring the fund performance will also be on you since there won't be an adviser to send you a consolidated statement of your investments. This means sifting through all the mutual fund statements and keeping tabs on every transaction, change in fund attributes, revision in expense structure, etc. For the uninitiated investors, the direct plan route could be cumbersome.

Says Kumar: "The first-time mutual fund investors will find the going tough. It will be worthwhile to get professional assistance for your first steps in mutual funds." Maalde adds, "Even if you are able to pick good quality schemes on your own, you will miss out on timely rebalancing of the portfolio that advisers are well-equipped to handle."

If you're thinking of switching from your existing equity scheme to a direct plan, you will need to consider the tax implications. If you had invested less than a year ago, you will have to pay an exit load of 1% of the total value as well as incur capital gains tax if the latest NAV is higher than the average NAV. In the case of an ongoing SIP, the units bought in the past year will come under this net.

If you want higher returns from your mutual fund investments, direct plans will be more profitable. Over a long period of time, the difference in NAV will grow to a hefty amount. "Savvy investors with large portfolios will benefit considerably over time," says Kumar.

However, be mindful of the accompanying issues involved in investing without professional advice and support. If you can't devote time and energy to research the right scheme to invest in and complete the various formalities, it is advisable to stick to your distributor, who will take commission expense from your investment, but will also offer you peace of mind.

Ideally, wait for some time to see how the direct plan route fares and the benefit that the existing funds are offering before taking the plunge.

source: ET