Since Jan 1, 2013, all mutual fund schemes now come in 2 variants – a regular plan and a direct plan. You may ask what is the difference?
A regular plan is one, which you invest in through a mutual fund distributor and for which a distributor earns a commission. The distributor could be your friendly neighbourhood one or an online distributor like FundsIndia, Scripbox, ICICI Direct, etc. Even your banks – HDFC Bank, ICICI Bank or Axis Bank are all distributors. With all them, you can invest in regular plans only.
These distributors receive ongoing commissions, called trail commissions as a percentage of the value of the investments that you have invested through them which is typically upto 1% of the investment value. In return for the commissions, the distributors offer you various services like advice, help with transactions and support with reviewing your portfolio, etc.
The cost of such commissions is inbuilt into the expenses of the mutual fund and is paid by the mutual funds directly to the distributor. Typically, you don’t have to shell out anything separately.
All mutual fund distributors are registered with Association of Mutual Funds in India or AMFI. They are assigned an ARN code that they mention in all the transactions that are routed through them. It allows them to receive a commission as well as take up servicing issues with the Mutual Fund or the registrar on behalf of the investor.
In case of direct plans, the investor can bypass the distributor, basically NO distributor, and invest directly with the fund house. In the bargain, the investor saves all the brokerage and commission that are otherwise paid to a distributor in a regular plan.
Regular Plan vs. Direct Plan – what else?
First off, since there is no distributor involved in a direct plan, you straight away save on distribution expenses. Hence, the direct plans are able to deliver higher returns purely on the basis of these savings.
You would note that there is no difference in the portfolios of a direct plan and a regular plan.
So, distribution expenses are the key key difference between the two types of plans. Take a look at the table below.
Difference in Expense Ratios / Returns for Regular and Direct Plans
Note: The expense ratio has been sourced from Valueresearchonline. The returns are calculated as CAGR for the period from Jan 1, 2013 to Oct 19, 2015. Direct Plans were introduced only on January 1, 2013.
As you can see in the expense ratio columns, the expense ratio of direct plans is about 40% lower than the regular plans. This entire amount is reflected in the higher returns (see the column on the right hand side).
In the returns column, you see that the 3 funds that are used as an example here have delivered an average additional 1% return, every year.
Hmmm. But is it such a big deal? Let’s find out.
Why is the direct plan such a big deal?
I would agree that 1% doesn’t sound much but if you look at the impact of it over say 10 years or 20 years on an ever-increasing corpus, the difference is huge. Thanks to the power of compounding.
Let’s do a simple calculation to understand this better.
For the purposes of illustration, we will assume that the regular plan would deliver a return of 12% compounded and the direct plan return to be 12.75% compounded year on year.
As you will note, we have a taken a lower difference of just 0.75% between the two plans.
We will take two investments – one a lumpsum investment, and the other an SIP or a systematic investment plan. So, here we go.
Example #1 – If you invest Rs. 1 lac (100 thousand) lump sum today
In the first 3 or 5 years, the numbers don’t look too big but by 10 and 15 years, you see an eye-popping additional returns of 58% and 138% of your original investment. Believe it!
Example #2 – If you invest via an ongoing SIP of Rs. 10,000 per month
In this case too, in the first 10 years, there doesn’t seem to be too much of an impact to care for. But let time fly and by years 15 and 20, the difference becomes huge.
If you were to consider each SIP as a lump sum investment, the difference would be as high as in the previous table.
Now, these are based on 12% and 12.75% returns for Regular and Direct Plans respectively. If equity as an asset class were to do as good as it has done so far, the difference would magnify by another multiple, which means higher returns for you.
Just imagine, all the additional things you would be able to do with the additional money you have got at your disposal.
So, you see, it’s totally a super big deal.
Ah! I know what is the next question on your mind. 🙂
“How can I invest in direct plans?”
Let’s begin with where you cannot. Your bank, online platforms and your mutual fund agents do not offer direct plans. You invest in regular plans with them.
For investing in direct plans, you would have to approach the mutual fund’s own office or do it through their websites. Alternatively, you can also approach their registrars like CAMS and Karvy.
Or, you can invest in direct plans using an online platform I have built for you – Unovest.
Click here to create your FREE account.
Should you go for Direct Plans?
The idea behind direct plans is to offer the informed investor a way to compensate herself for the work that otherwise would be done by a distributor. By investing in a direct plan, she does away with the cost of distribution and benefits in terms of higher returns.
However, caution has to be exercised in making your selection of funds. You should be able to spend the time and effort towards building your portfolio and monitoring it on a regular basis.
If you are not upto it, you can hire the services of a professional investment advisor. For a fee, the advisor can understand your requirements, build a portfolio for you and help you track and review it on an ongoing basis.
This way you would be able to make the best of both the worlds.
Very Important
- One key requirement when you invest in a direct plan is that your form should mention “DIRECT PLAN”.
- In case of online transaction through the mutual fund website or through the registrar like CAMS, you have to choose the plan which has “Direct” mentioned in front of it. For example, HDFC Equity Fund – Direct Plan, or, Franklin India Bluechip Fund – Direct Plan.
Between you and me: So, are you going direct too? How do you select your funds? Which platform do you use to invest – your bank, broker or an online platform?
Hello Sir,
I am planning to invest in mutual funds and SIPs, (I am 28 years old and working in a private company). I dont have any exposure in this. So please suggest, How do I start? Which mutual fund is the best option? Initially i would like to start with SIP (rs.3000 per month)and i can invest at least for 3-5 years. SO, How should i start with – regular plan or direct plan, through Web portal like Funds India/scripbox/myuniverse or any local agent.
pls help me i am planning for a long time but i am not able to finalize. Thanks!
Dear Nilesh
If you are not sure which funds you should invest in, I would recommend that you take advice.
You can use Unovest at http://www.unovest.co and not just take advice but also invest.
You should continue reading and learning about investments.
Regards
hello, my self manisha trivedi i am also distributor with licence of AMC. But please your review is good and genuine for direct fund house ans distributor. i suffered from this thinking of that distributors are not genuine. they earn high value from us. i am worried about then why should we get exam and certificate of AMC . there are lots of big companies not prefer to invest with distributors. where I entered for marketing very second day the answer is we are going direct fund house. i request please highlight the diffrence between distributor and fund house.
Manisha, I am not sure if I understand your question.
I am trying to substantiate my decision to move to direct plans.
Where I am stuck is:
Investment:
If I invest 17500 each month for a period of 10 Years and I have taken that 1% of my total investment is charged as commission
What I think is actually happening: Please feel free to correct the flaw in the calculation I may have made.
I have reduced my investment from 17,500 to 17,300 as of the 17,500 , 1% is deducted by the distributor and only 17,300 is generating the interest.
Every month my SIP is 17,500, assuming 1% commission each month my investment is becoming 17,300.
17,500 @ 15% will give me 48,76,502. However because of the 1% commission my return is calculated as 17,300 @ 15% will give me 48,20,771
So net loss because of the commission is 55,731. This loss is basically incurred on the 2,400 that is being charged as commission every year and not earning 15% interest which my investment is generating.
What is projected on lot of websites:
In the example that I used above Websites are saying return is 15% instead of 14%. 1% loss due to commission.
17,500 @15 % will give me 48,76,502 and what you mentioned is the cost will still be 17,500 but the return will be 14% which would give me 45,86,599.
The projected loss here is 2,89,903.
I am not sure if discount the 1% in the return (15% vs 14%) is justified or the cost (17,500 vs 17,300) is justified.
What am I missing here?
Hi, Typically, the commissions are paid out every quarter on the current value of the investment. That’s what you should incorporate in your calculation.
Thanks
Ty! For the reply.
Are you saying the deduction is happening on the return and not cost?
Because there is a huge difference in the projected loss due to commission.
If you can take an example , it would very helpful. Thanks for your time!
The commission is paid on the full value of your investment. For example, of your current value is rs 1 lac then1% of the same that is 1000 is the commission. When it increases to 5 lac, the commission will be rs 5000, of it drops to 70,000 then the commission will be 700. Year on year this is how it is done.
ty for the quick reply. I understand that commission is charged as a percentage of the investment and could very depending on the money that is actually invested. So to precise as stated in your example commission is charged on the cost. So I don’t see much of a need to shift to direct plans . Because loss that is being projected on all the websites is overstated.
Not sure why you would think so. It is not on the cost but the current market value of the investments
Sorry my bad! I misunderstood your example, thought the commission is on the cost, But you were mentioning that the commission is charged on the future value of the investments.
For the benefit of the readers I am summarizing what we discussed: Commission is charged on the investment return, that is if investment on a direct plan gives a return of 15%, Assuming an AVG commission of 1 % a regular fund will give a return of 14%
Thanks for patiently answering my queries!
Great! Thanks.
Hi Vipin,
Nicely explained. for the last few days i was searching for a best answer for my dilemma. The difference between both. Yes. Now i clearly understood. if it is a short term, it wont affect much. Thank you very much.
Thanks Praveenlal. Glad it helped.
Could you please explain how returns are calculated for direct funds, for example if the fund generated 0.03% for a day, would it translates to 30 rs per lac or there would be any other charges that AMC would cut for dirct fund too?
Hi Chetan
When we calculate returns for any fund, they are calculated from NAVs that a fund declares. An NAV stands for the Net Asset Value of the fund which is equal to the total market value of all the holdings of the fund minus any expenses.
In case of a direct fund, these expenses are lower than the regular plan (on account of no distributor expenses). Hence the NAV is higher and hence the growth % is also higher.
To answer your question specifically, once the NAV is out, there are no other expenses that are deducted from the fund. Hope this clarifies. Thanks.
Can the existing regular plan investments be converted into direct plans?
Yes of course, regular plan investments can be converted into direct plans. Just make a switch transaction from regular plan of your fund to the direct plan.
Do keep in mind the exit loads, if applicable as also any incidence of short term capital gains tax.
For equity funds, if you do the switch after 1 year, typically there would be no tax and no exit loads (except for some funds).
For debt funds, Less than 3 years could result in a short term capital gains tax.
Wow, compounding is unintuitive, both that your original investment of 1 lac became 10 lac in two decades, and that the difference in returns between two investments also compounds, to the point where a 0.75% difference becomes a 100% difference. Amazing. Thanks for illustrating this so graphically!
Another way of calculating the difference is as a percentage of the final value (for the direct plan). By this measure, you’d have lost 12% of your final corpus if you’d opted for a regular plan.
Yes, it is.