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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12 thoughts on “The indirect cost of direct plans

  1. When the investment tenure and correspondingly the value grows, definitely the Regular plan’s commission/distribution fee eats into returns significantly vis-a-vis Direct plans. There is no denying this.

    What’s wrong with a fee-only planner advisor doing a full-fledged financial planning exercise as per the goals of the client and advise the client on Investments in Direct plans – There is no conflict of interest here and a win-win situation for the client/planner.

    1. Hello Sir, Thank you for taking time to share your views. Our point was more on the direct platforms offering Rs 100 service and what ti will not offer. You are right that pure planning/advisory will definitely lend better credibility even if we remain unbiased in our present form. However, in the indian context, most investors think advisory is a one-time exercise and therefore requires only a one-time fee. Like we discussed it is the review and rebalancing (and not just planning and choosing funds) that needs ongoing monitoring and service and is the key to wealth generation. Unfortunately in the Indian context, investors are yet to realise this as a fee-worthy exercise. Thanks, Vidya

  2. If you see the list of all actively managed mutual over the period 10 years, you will hardly find any of them beats the Index, why paying regular funds of 2-3%, even why direct funds for 1%.

    Over the years, it can eat more than 50% of total wealth. Don’t make investors full by selling junk for commissions, educate better strategy like JACK BOGLE did 35 years ago…

    1. Hello Abhishek. We appreciate your feedback.

      A quick analysis of fund returns and comparison to their benchmarks shows us that over the past 10 years, 97 out of 115 actively managed open ended equity funds have beaten their benchmark indices. That’s 84% of the funds beating their benchmark. Over a 5-year period, this percentage is 85%, even as the number of funds have gone up to 158.​ ​The inability of actively managed funds to beat the index is true for mature markets like the US. Indian financial markets are yet to reach that stage. ​

      A 1% extra expense ratio does not create a difference of 50% in total wealth. You might have been mislead by the ads which we spoke about in our articles. A 1% difference in return will create a difference of about 12%-13% in your corpus value over a period of 20 years​ (assuming you ​invest in the exact same funds​ over this period)​. However, most investors do not possess enough knowledge to ​understand the nature of funds, ​pick the right ​ones for themselves and monitor their portfolio on their own​. We have explained this in the post​.

      ​There is a lot to be gained by investing in actively managed funds.

  3. Suggestion : If should provide an option for the customer using fundsindia to go ahead with direct plan with no [service cost] additional cost . Lets the customer choose whether to go with expert advise or not. As we have fexi- SIP , regular SIP’s likewise should allow with Direct SIP wherein customer should select on their own with no hidden cost [ units to be purchased for the total amount spent]. Such transperency would allow customer to choose and build trust on fundsindia team.
    [ Please don’t reward me for the wonderful suggestion :)]

    1. Piyush, thanks for the suggestion 🙂 If I get no fee from you (since you say no service cost), please tell us how we can thrive and continue to serve you? 🙂 Please name a price for servicing you instead of saying free 🙂 If there is a meeting point between what csutomers can afford and what we need to sustain business, we certainly will 🙂 thanks, Vidya

  4. I think it is doable, Vidya. Think about enabling direct funds for investors who holds 1Lakh+ (for example) in regular funds? You get paid anyway with their existing portfolio and allow them to invest in direct funds. Just an example but you guys are the best to figure that out and take decisions accordingly.

    In simple, everything is doable in this digital world and I hear you – “there is no free lunch in this world”.

  5. Hello FundsIndia,
    Now a days we have seen few more online platform providing Direct MF plans free of cost such as PaisaBazaar, ClearFunds etc. And now PaytmMoney has also jumped into this competition by providing Direct Plans with Zero charges.
    All these platforms also mention of providing service like advise, customer support etc.
    Here i would say, Fundsindia would be lagging behind such platforms as the only advantage for us with Fundsindia was their best advises and services.
    FundsIndia will have to think about this seriously. Fundsindia gained tremendous popularity, growth & client base at the initial stage when people wanted to get rid of paper / document transactions. Even with only Regular plans, investor preferred Online platforms for their day to day investments as it was hassle free.
    However now the market has gone one step ahead by providing the same platform / service for Direct plans with free of cost.

  6. Hello FundsIndia,
    Now a days many online platform have come to the market with Direct MF plans with free of cost such as PaisaBazaar, Clearfunds etc and moreover now PaytmMoney as well jumped into this competition. These platforms also provides advisory services and Customer services as well.
    Here i would say that Fundsindia would be lagging behind, as so far the only edge with FundsIndia was their best advisory services and customer support free of cost.
    FundsIndia now will have to think about this seriously. Fundsindia gained tremendous popularity, growth & Client base when people wanted to get rid of paper / document transaction for their day to day MF transactions.
    However with Direct MF platforms providing same sort of services and Direct MFs, people are now moving towards Direct MF platforms.
    As higher return in Direct MF vs lower return in Regular MF is the only thing which would matters for the investors now.

    1. Hello Udaya,

      I am sorry for the delay in responding to you. Returns may be the only thing that matters but is that returns easy to come by? If it were, all money should be in stocks 🙂 Or for that matter, we would not have investors who invested by themselves now asking us if they are holding the right debt funds 🙂 Choosing the right funds is never easy; maintaining and reviewing is even harder. This is the real reason why very little money goes to stocks, which is the cheapest mode of investing, even compared with direct plans, right? Similarly, there is a difference in what is offered between a direct platform and regular. Direct platforms, like you said are well, just online platforms to enable investing. The invested portfolio needs tending and if an investor can do it himself, he sure doesn’t need advisory help. If he cannot there is a ‘right cost’ from the investor’s perspective and from the advisor’s perspective. My argument is that it is not zero nor Rs 100 per year offered by platforms that are likely using your precious profile to sell other products. At FundsIndia, we will seek to provide value add through products that will not be available elsewhere or in the form we offer. Besides, I cannot think of any platform where you can mail to get your entire portfolio reviewed. Thanks, Vidya

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