Insights

The indirect cost of direct plans

June 18, 2018 . Mutual Fund Research Desk

In recent times, we have seen quite a few advertisements and promotions for direct plans of mutual funds. They talk about how much you stand to lose if you invest in regular plans of mutual funds as opposed to direct plans. When you ask us about this, and we try to explain, some of you immediately retort by saying that our advice will be biased because we are distributors.  Since it’s hard to hold a conversation that way, here are some points we wish to clarify.

First, we found that not all of those calculations put out in these advertisements are correct, most are highly exaggerated. Our objective here is not to get into it since it serves little purpose. We have no qualms in letting you know the simple math. Direct plans will always be cheaper than regular simply because there is no distribution fee built into it.  But we do want to tell you why direct plans may not be as rosy as these advertisements make it seem.

The reason regular plans exist

The first thing one needs to understand is why the concept of regular plans exist at all. When a person helps you buy and sell mutual funds, they incur a cost. If you go to a financial advisor/distributor, they will not only take care of the transactional hassles, they will also help you with your investments. All this costs money to the advisor. They need to dedicate their time and effort to make sure that your money is invested in the right way. The extra expense ratio charged in the regular plans is used to compensate the advisor for their effort.

How financial advisors can help you

You might wonder if the services provided by the advisor are really worth it. This happens because most people underestimate the services that advisors can provide. This article gives you a lowdown on the what  a ‘good advisor’ (please note that a relationship manager is not the same as an advisor, leave alone a good advisor) can do for you.

Help you understand and quantify your financial goals

Goal based financial planning may be time consuming. When you have multiple goals, you might get lost trying to identify and quantify each of the goals. However, a financial planner does this on a daily basis. They are adept at identifying the right goals and creating financial plans for them. With the help of an advisor, you will find it much easier to plan for your financial goals.

Help you decide on the right asset allocation and the right funds

Do-it yourself (DIY) investors usually look at the highest rated funds or pick the funds with the highest 1-year returns. They may be the better funds by virtue of being highly rated, but are they really suited to your needs? A financial advisor not only understands your requirements, they also understand fund characteristics. They not only select the best fund for you, but, more importantly, select the fund most suited to your needs. There is a marked difference in this.

Help you distinguish between funds

A DIY investor who looked at chart toppers and bought funds in the past couple of years, would most likely have picked mid and small-cap funds. Such an investor would have been in for a rude shock in 2018, seeing all the funds fall together. This is exactly the kind of investment decision that an investor can make if they think picking a fund from a rating website is easy.

Let me take another real-life example. A CFO of a large company, who prefers to invest directly, spoke to my colleague about BOI AXA Credit Risk fund. He spoke about why it is a great fund given the high returns. Little did he know that this fund, on top of being a credit risk fund, has close to 20% of its investments in unrated securities. To add to that, It also had very concentrated exposure to some of its top risky holdings. A fund manager should try to mitigate the risks inherent in a credit risk fund. This fund added to it with unrated securities and high concentration! This understanding of the underlying portfolio, risks and quality is not something that simply comes in packaged portfolios of AMCs or direct platforms.

Help you review and rebalance

Goal planning, allocation and choosing funds is just the beginning. Real wealth building lies in maintenance. A periodic review off the fund performance, through scientific, quantified analysis by an exclusive research team is not something any direct platform can offer on a sustained basis. They likely do it one time to recommend funds initially and offer them like commodities. That, to our mind, is neither advisory nor research. Mutual funds are not commodities yet. And in the Indian context, trying to promote them as one can hurt, not the seller, but the investor.

Help you tide through volatile markets

When investors lose money in the market, they tend to panic. Many investors withdraw their money or stop their SIPs. These are exactly the type of counter-intuitive decisions that hurt your portfolios. Advisors help you understand why the markets are falling and why there may not be any reason to panic. A correction offers a good opportunity to invest more money. And advisor helps you understand this and use this opportunity to help you stay on or buy more at lower costs.

Help you devise a withdrawal strategy

Good advisors don’t simply  tell you when and where to invest. They also tell you how and when to withdraw the money, when you need it. Whether it is about any emergency need or shifting money to safer avenues, closer to your goal, a good advisor will help strategize those.

Help manage monthly income after retirement

Most people above 50 wake up to the fact that they haven’t planned for their retirement. Some retire and then have no idea how to generate sufficient income from their corpus. Those who do, regularly ask us about dividend options to earn regular income or invest in some equity fund to generate ‘regular income’. We help such investors not only understand how to generate income from their corpus but also help them grow their corpus with limited risks.

Your financial journey

A financial advisor doesn’t just look at your bank balance and tell you where to invest the money. A financial planner can hand-hold you through your financial journey. They can give you a holistic view of your requirements and plan your investment, insurance, and income streams.

When it comes to investing, investors get fixated on the costs. In other areas of life, it is easy for people to understand the need for paying experts to get their job done. But financial planning is something people think they can do on their own. This view may have been correct when bank deposits and NSC were the only options. But with today’s financial markets, that is not the case. And an investor could benefit a lot by talking to their financial advisors about their investment needs.

Yes, when it comes to the cost of such advice, you do have an option of paying a good financial advisor a fee for the service. But to think such a fee will be lower than the present distribution fee is a bit of a stretch. If platforms do offer you such low-fee services, please think a bit about how many banks and how many products like debit cards or credit cards or demat accounts or any ‘free transactions’ were offered for free initially and then charged later. A simple math will tell you that it is yet another marketing gimmick.

For most of these ‘free’ direct platforms or Rs. 100 direct platforms, their revenue will come from cross-selling higher-cost products such as insurance or equity trading. To them, direct plan investors are ‘leads’ to generate higher fee from other products. In other words, you think you are saving Rs 10 today, only to be fleeced Rs. 100 in a higher-cost product cross-sold later.

If you are a discerning, confident investor, you have an option to go direct. For the rest it is about paying ‘all-inclusive’ (for advisory and platform or paper services) with regular plans or paying a fair price separately. There is nothing in-between in any viable advisory service.

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