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Direct plans are hugely underappreciated

In spite of the fact that direct plans are more lucrative than their regular counterparts, the assets under them are yet to grow meaningfully

Direct plans are hugely underappreciated

Most of our readers are aware of direct plans which came into effect in January 2013. Since direct plans don't have distributor commissions, their expense ratios are quite lower than those of regular plans, varying between 50 basis points and 1.25 percentage points.

Investing in direct plans is no rocket science either, especially if you are internet savvy. A host of online platforms, such as Mutual Fund Utility, are now available for investors willing to invest in them. Of course, you can also invest in a direct plan through the respective AMC's website.

However, in spite of a lower expense ratio and ease of investing, direct plans have made little headway over the past six years, constituting only a meagre portion of the industry's assets (see the first graph). Why is that so? Perhaps the reason for investor apathy towards direct plans lies in not understanding the difference that they can make over the long term. Why worry when the difference is just 1 percentage point?

Well, you do have reason to worry. Let us delve deeper into this with an example. Suppose you invest Rs 10,000 every month in the regular plan of an equity fund. Assuming a modest 12 per cent return, you will end up with a corpus of Rs 3.53 crore at the end of 30 years. Had you invested in a direct plan, the return would have been higher at 13 per cent, owing to the 1 per cent lower expense ratio. So you would have accumulated a corpus of Rs 4.42 crore, making yourself richer by Rs 89 lakh (see the second chart). That's a lot of extra money for just making a small switch.

But direct plans are not meant for all investors. If you need the assistance of a distributor to invest and keep yourself motivated, go for regular plans. A good distributor can simplify the investment process. Otherwise, it makes sense to make the switch.

Just be careful about the capital-gains tax and exit load while moving your investments. If you sell your equity fund within one year of buying it, you have to pay a 15 per cent tax on the gains. If you sell after one year, you have to pay a tax of 10 per cent on the gains above Rs 1 lakh. Lately Franklin Templeton India has made the switch from regular to direct free from any exit load. If more AMCs do this, that will likely boost the assets commanded by direct plans.