In 2012, the Securities and Exchange Board of India (Sebi) had mandated mutual funds to differentiate between direct and distributed plans in mutual fund schemes.
In 2012, the Securities and Exchange Board of India (Sebi) had mandated mutual funds to differentiate between direct and distributed plans in mutual fund schemes. It was implemented from January 2013. Direct plans give higher returns than regular plans because of the lower expense ratio.
Investors can buy direct plans of mutual finds from asset management companies (AMC) directly and save on the commission paid to the distributors. The idea is that those investors who are not using the sales channel should not bear the cost of distribution. If an investor can identify suitable good funds to buy and do documentation like form-filling and KYC, then why would he pay commissions?
This path-breaking move provides an edge to investors investing in direct plan without any incremental effort. This was done to promote the direct plans, that effectively invest more of the savings and help investors earn extra return.
A regular plan is sold by an independent financial advisor (IFA) or a distributor of mutual fund AMC. The IFA gets 0.75-1% as upfront commission and annual trail commissions on continued investments of 0.5-0.75%. It helps in selecting the plan according to the investor’s risk profile and does the required documentation. Alternatively, Sebi registered investment advisors, operating on ‘fee only’ model can help an investor select the right funds for a fixed fee, which is much lower than upfront and trail commissions paid to distributors.
The impact is more significant for systematic investment plans (SIPs). Every SIP contribution is treated as fresh investment and distributor gets upfront commission on every SIP contribution and a trail commission on accumulated corpus.
So far as documentation is concerned, it is better to handle your KYC proofs yourself instead of giving it to someone. Also, you can specify email, phone number, nominee details, etc., as you want. Many schemes are offered online from fund website and platforms like CAMS.
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Let us understand the impact of upfront and trail commissions on wealth creation in an equity fund where the expense ratio for direct plan is lower by 0.7% than that of regular plan. Suppose you have annual investment of `6 lakh in a mutual fund scheme which earns 14% return. Assume that you begin investing at the age of 30 and continue till retirement at 60.
Now, direct plan gives you 14% annual return. However, since due to commissions paid out of your money, NAV of regular plans will be lower and give you about 13.7% per annum return. Further, if the amount is reinvested at the time of retirement into a conservative scheme till age 85, this investment continues to earn 10% in direct plan and 9.7% in regular plan.
The impact over the lifetime on total wealth created is huge. The difference at the age of 60 is a whopping `2.76 crore. If the investment is not withdrawn till the age of 80 and 85, the difference widens due to compounding effect and becomes more than Rs 73.78 crore and Rs 134.98 crore, respectively.
Recently, SEBI has asked funds to clearly disclose commissions and incentives passed on to distributors along with visual representation.
So, why not increase your effective return on your investment by investing directly. Or, pay your advisor a one-time fee for selecting the right fund and avoid paying commissions to a distributor.
The author, Nehal Joshipura is faculty member in the finance department at DSIMS, Mumbai