Why should you invest in Direct Mutual funds?
A lot of first-time investors think that a regular mutual fund is better because of the name ‘regular’. And when the advisor mentions about ‘direct’ mutual fund, the first-time investor often attaches negative view on ‘direct’ word.
Let’s understand the difference between a regular mutual fund and a direct mutual fund
Each mutual fund scheme — be it equity or debt — has two plans to offer, regular and direct.
The direct plan cost is lower than the regular plan to the extent of commissions paid to distributors.
In both the cases, you are buying into the same portfolio but at different costs.
Why is the expense ratio lower in case of a direct mutual fund?
In simple terms, because you do not pay any commission or brokerage to the agent in case of a direct mutual fund.
Let’s understand how mutual funds make money: through an expense ratio or management fees.
The expense ratio is the cost expressed as a percentage of assets that would be deducted from mutual funds. The ratio is an annual figure but gets reflected in the daily net asset value of a scheme.
Expense ratio matters as it takes away from your overall return. The higher the expense ratio, the lower will be your net return. Cost isn’t the primary factor for investing in an equity fund, but it matters.
In case of mutual funds, the impact is higher as costs can vary (subject to an upper limit) among different schemes.
Who defines the expense ratio?
Mutual fund schemes charge expenses in a tiered structure, as per guidelines prescribed by the Securities and Exchange Board of India (Sebi). As more assets get added, the incremental expense ratio is lowered. Ideally, a scheme which is growing in size should see lower not higher expenses.
For equity funds, the maximum expense ratio chargeable is 2.5%, plus 20bps can be charged in lieu of exit load and another 30bps can be charged for inflows garnered from B15 locations, taking the upper limit to 3%.
Direct mutual fund expense ratio will be lower than a regular mutual of the same scheme. The difference in case of an equity mutual fund is ~0.7%-1% and debt mutual fund is ~0.3%-0.5%.
How does the expense ratio impact your portfolio?
For long-term investors, just as returns compound, annual costs also compound. This is the advantage of well-priced direct plans—they give self-guided investors a return boost.
Who should invest in a direct mutual fund?
Direct mutual fund plans aren’t meant for all investors. Don’t simply jump after low cost.
If you were to pick a direct mutual fund, you have to directly deal with a mutual fund company. An agent will not have an incentive to serve you. However, SEBI has allowed investment advisers who are registered with SEBI to offer direct mutual fund.
It is better to work with an investment adviser who can understand your needs and create an asset allocation. An adviser can offer conflict-free advice and manage your investment portfolio in direct mutual funds.
There are a few online platforms that offer direct mutual funds but you need to know how to manage your portfolio. Direct plans may also not be the best option for investors who don’t have the time to manage a mutual fund portfolio.
If you are a seasoned investor who has found the right platform to access direct plans, keep in mind that expense ratios are dynamic and it is prudent to add it to the tracking list along with performance and risk parameters.