September 24 , 2014
One of the best things SEBI did in 2012 for investors was to introduce 'direct' plan for mutual fund schemes. Starting 1 January 2013 all mutual fund schemes have a direct option for investment.
What is direct plan in mutual funds?
A part of the expense ratio (an annual recurring charge on all mutual funds) goes towards distributor fees. If you choose direct option your money will be invested in the fund directly without a distributor's involvement. Direct plans have separate NAV and lower expense ratio. And lowered expense ratio automatically translates to higher return on your investment.
This works just like buying from factory outlets or still better the source. Middlemen in the retail chain add up cost of products in your hands. If you had time and experience to judge quality and the source were not too far you'd rather go to it than a retail store. The same is true with financial products.
Though right now no one knows how much exactly, experts have estimated that at current expense ratio structure, direct plans can give 0.5-0.75% more in returns. And mind you, if it's long term investment like in equity funds, even a 0.5% difference can make you richer or poorer by a couple of lakhs as it compounds over the years. In fact some of you might have invested in mutual funds without a distributor earlier and skipped the transaction fee but now you get higher returns too for doing so.
Should I opt for direct plan?
Whether you should buy mutual funds through direct route or not depends on your level of mutual funds awareness and whether you would be comfortable doing things all by yourself.
Selecting the right mutual fund is not an elephant task (was not meant to be. SEBI is trying to clean up the mess). Anybody who is willing to spend some time on basic research can do this and be duly rewarded. You can read reviews of funds, zoom in on a fund suited to your investment goal and invest in it directly. The whole procedure is not as daunting as it may seem.
2. Time and comfortability
If you are used to an investment service account (ISA) of a bank, through which you can invest in mutual funds online, monitor how your funds are doing and sell them when you wish, switching to direct fund would mean a lot more effort on part but obviously in the long run it would pay off richly.
Every single activity like buying units, top-up in SIP, changing personal details, etc will have to be managed on your own. And if you hold a couple of funds belonging to different fund houses you'd have to initiate procedures separately for each of them. Many mutual funds allow you to transact with them online but the first time it has to be in person for all of them.
If you are willing to compromise on comfort and do those one-time stuff yourself you would be left with more money in hand down the years. This is more so if the investment is of large amount (say a monthly SIP of Rs 3000 or more) and is for a long period.
What to consider before switching existing mutual fund plans?
You might have to bear some expenses while converting investments to direct plan, depending on how long you have held the investments and type of mutual fund.
1. Exit load while switching to direct plan
Exit load is applicable if switch is made before the exit load period is over. This is applicable in case of SIP/STP as well. However investments that were made without a distributor will be exempted from exit load. Once exit load has been charged you can convert to another plan again without being charged again even if it is before exit load period has ended.
2. Capital gains tax while converting to direct plan
Switching plans will be considered as redeeming units so capital gains tax will set in. In equity funds long term capital gains are zero if redeemed after one year of buying units. Short term capital gains work out to 15%.
Consider these to arrive at whether it is best to wait until exit load period is over and long term capital gains set in before you switch. Presently debt funds have lower exit load and also lower expense ratio (in the range of 1.25-1.9%) but if they go up it will be worth it to switch. Equity funds have higher expense ratios in comparison.Conclusion
Direct plans would definitely give higher returns in the long run than regular plans. This is truer about equity plans which have higher expense ratio. You should go for direct plan if you have at least basic level understanding about selecting funds and are willing to spend some time doing the initial requirements yourself. Before switching existing investments try avoiding exit load and short term capital gain tax.