Mutual fund is a mechanism of pooling money from various investors who wish to save or generate returns on their capital. Investing in mutual funds is a lot easier than buying and selling stocks and bonds, but at the same time generates returns on par with these investments. Mutual funds provide the advantages of economies of scale, liquidity, professional management, diversification, regulatory benefits and many more. Investment in mutual funds has been rising at a fast pace. Broadly, mutual funds are available under two plans:
1. Direct mutual funds
2. Regular mutual funds
Regular mutual funds:
In the regular plan, an investor buys mutual fund units through an advisor, broker or distributor. In regular mutual funds plan, the mutual fund company pays commission to the intermediary. Therefore, the expense ratio is higher over here and return is lower. This is in lieu of the advice and guidance offered by the intermediary. This especially makes sense in the current market because an average investor is exposed to more than 5000 mutual fund investment options and often leads to confusion.
Are the higher expenses and lower returns a spoiler for the regular plan?
Direct mutual funds:
A direct plan in mutual funds is what an investor buys directly from the mutual fund company, without any involvement of agents, brokers. Due to the absence of involvement of an intermediary, there are no commission expenses. Hence, generally, the expense ratio remains lower in this case and the return on investment is higher as compared to regular mutual funds. Direct Plans offer about 0.75% to 1.25% higher returns than regular plans due to lower expense ratio.
Can this higher return justify an investment in a direct plan?
Regular plan v/s direct plan
1. Regular plans are relatively expensive but the expense of commission is generally a small amount surrendered for the services rendered by a broker, who helps an investor make higher profits. These profits can be earned even by an amateur, having no knowledge of investment plans.
2. The intermediaries provide investment recommendations as the choice of investment in mutual funds is bit critical. The choice of a fund can lead to an outperformance of as much as 4-5% in some cases, thus justifying a 0.75-1.25% return.
3. The intermediaries or distributors even offer investment services such as periodic review or rebalancing, asset allocation and other aspects of financial planning. The advisor helps to improve the performance of holdings and increase the rate of return. These prudent practices could even increase the return by over 1-2% in the long term. However, the payment of commission and this expert advice is not a guarantee of an outperformance.
4. Direct plans, on the other hand, give investors the independence to research and make the best choices. Most of the information is available in the public domain albeit the authenticity and reliability offered by some websites and blogs is questionable and may result in losses to the investor.
It is recommended to perform investment under professional supervision thus making regular plans attractive to beginners and fresh investors. Precisely, direct plans are suitable for those who are willing to invest some time into their investments. It is not rocket-science, but it is definitely not easy nor recommended to everybody.
It is finally up to the intelligent investor to decide whether he wants to go that extra mile and save the 1% in commissions or follow experts, feel safer and hope that his investment performs better than the direct plans.