Understand the two routes of investing in a mutual fund and which option is better for you
10-May-2022 •Ravi Banagere
When you look out to buy or rent a house, you have two options. One is by doing it yourself, which would require you to hunt a lot of places, deal with many landlords and invest a lot of your time and effort to finally find that one property that fits your budget and other preferences. The other option is to take the services of a broker who acts as a mediator between property owners and people like you. A broker understands your needs and shows you selected properties that are likely to meet your requirements. This simplifies your job of house hunting and in return, you pay some fees to the broker for his services.
Similarly, in mutual funds, there are distributors or brokers who help investors with mutual fund investing and take care of the investment process on behalf of the investor. In return, the distributors and brokers charge a fee for their services. Such mutual fund schemes are called 'regular plans'.
While in the case of a 'direct plan', the investor has to take care of everything, including the selection of funds.
So, every mutual fund scheme comes in two variants - a direct plan and a regular plan. There's no difference between the two in terms of portfolio, fund management, etc. The only difference lies in the expense ratio charged from the investors, which is higher for the regular plan as the mutual fund company has to pay a commission to the agent/distributor. You can think of it as any product purchased from a wholesaler vs a retailer wherein the price charged by the latter is higher for the exact same product as the retailer charges commission or profit on top of the wholesale price.
Which plan should you go with?
Direct plans have a lower expense ratio (lower by around 0.5-1.5 per cent), so they are poised to give you higher returns over the long-term. Here is an example to illustrate the impact of the same on your investment value.
Suppose you invest Rs 1 lakh in a fund for 10 years. The fund returns 15 per cent p.a. during this while. With the direct plan having an expense ratio of 0.50 per cent, your corpus value would become Rs 3.87 lakh. But if you choose the regular route with an expense ratio of 1.5 per cent, you would accumulate Rs 3.54 lakh, i.e., 8 per cent lesser returns as compared to the direct plan.
Earlier, regular plans had a strong case because of the paperwork and various other things handled by the distributor. The purchase and the redemption process, changes in investment mandates or personal details, etc., were all taken care of by the broker. In direct plans, the investor has to go through the hassle of handling all these things by themselves. Today, it's all digitised and most of the work can be easily handled online. So, from this standpoint, there's not much difference between the two plans now.
To sum up-
Go with direct plans if you are a net savvy, do-it-yourself kind of person. They will give you more returns over the long-term. But remember that you'll have to do everything yourself - from selecting the fund to buying and selling, keeping track and deciding the future course of action. You may want to check out this video to know how to buy and sell mutual funds.
Go with regular plans if you find it unnerving to take complete control of your mutual fund investments as of now. What's more important at this stage is to start your investing journey. Better and wiser things will anyways follow over time. So it may not be a bad idea to start mutual fund investing through a distributor in a regular plan, even at the expense of paying a bit more. As you gain more knowledge and confidence over time, you can later switch to direct plans and start investing yourself. The only word of caution here is to stick to your investment plan and not get persuaded by any other investment option that the distributors may offer you as they have their own interests attached to it.