Should You Opt For Direct Plans of Mutual Funds?

Direct Funds or Direct Plans of Mutual Funds are of fairly recent origin. Till August 2009, mutual funds charged entry loads, which were used to pay commissions to sales facilitators. Since entry loads were to the tune of 2 to 2.5%, it imposed a huge upfront cost on the investor. SEBI abolished entry loads on funds effective August 2009 and asked distributors to separately negotiate any advisory commissions with the client. However, this was a non-starter till the time the benefits were palpable. Effective January 2013, all funds had to classify their schemes into “Regular Plans” and “Direct Plans”. The difference was that Direct Plans did not incur marketing, distribution and trailing costs and commissions and hence the load was lower on Direct Plans. Direct Plans had a lower TER (total expense ratio) and that helped these Direct Funds to generate better returns to customers.

What are the principal merits of opting for Direct Plans?

There are some clear advantages for investors in opting for Direct Plans over Regular Plans.

1. Direct Plans save the sales and distribution commission for the investor. Of course, that means that the investor will have to directly go and invest with the fund AMC, which is not really too difficult. But the savings are to the tune of nearly 1-1.5% on a typical equity fund.

2. The saving may look quite small in percentage terms but these are the annual savings. When you compound the same over a period of 20 to 25 years (which is your normal planning horizon), Direct Plans can make a huge impact on your wealth.

3. One can argue that the Direct Plan misses out on the advisory services provided by the distributor. But you always have the option of opting for an independent investment advisor who can weigh multiple options and advise you accordingly.

4. What is more important is that Direct Plans help you to delink the investment role from the advisory role. When you opt for a Direct Plan, you only pay for the basic operating costs of the fund, which is why your TER is much lower. But more importantly, there is more transparency in the Direct Plan because you exactly know what you are paying for.

5. Can Direct Plans fit into a financial planning exercise? Actually, Direct Plans will fit perfectly into an overall financial plan because the cost saving in a Direct Plan helps you to keep your overall cost low.

6. Direct Plans are more conducive to wealth creation in the long run. Let us take the same fund with Direct Plans and Regular Plans. The TER is taken 1.25% lower in case of Direct Plans and this gives the Direct Plan an edge of 1.25% each year. Consider the table below for a hypothetical 25 year return analysis.