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Financial Planning

Direct Mutual Funds- should you add them to your investment portfolio?

03 November 2016
Depending on your risk appetite and financial goals, here’s how to know if Direct Mutual Funds are the right investment for you.
 

To distinguish Direct and Regular mutual fund plans, you must understand the role of Asset Management Companies (AMCs) and intermediaries in the world of mutual fund plans.

AMCs create different mutual fund plans like small cap fund, mid cap fund, balanced fund, and so on. They appoint distributors and agencies to market their plans to investors. The money you invest in mutual funds is ultimately paid to a particular AMC, which will then invest your money as per the features of your chosen mutual fund plan.

In case of Direct Mutual Fund plans, you buy units directly from the AMC without going through any intermediary. On the other hand, when buying mutual fund units in a regular plan, you never transact directly with the AMC. You transact with the intermediary, and it functions much like a bank or any other financial institution.

Simply put, buying a direct mutual fund plan is like buying rice directly from a farmer. A regular plan involves buying rice from one of the many retail outlets spread all over your city.

Related: Types of Mutual Funds and How to Start Investing in Them

Direct and regular plans can be compared on the basis of the following parameters.

  1. Cost

A direct plan always has a lower expense ratio as compared to a regular plan. This is because in the case of a regular plan, the AMC has to pay a commission to intermediaries for marketing and distribution costs. These costs are usually recovered from the plan as an expense. A direct plan’s expense ratio, i.e. proportion of expenses to net assets, can be lower by 0.75% to 2% as compared to a regular plan.

This assumes greater significance in case of fixed-return or low-risk funds like debt funds or arbitrate funds. Lower expenses will translate into better returns, especially in case of long-term investments.

Smart Choice: Direct Plan

  1. Purchase Options

Coming back to the rice example, buying from a farmer, although cheaper, will not be as convenient as buying from a retail outlet. Similarly, investing in mutual funds is simpler if you choose to go through an intermediary offering professional assistance.

However, many AMCs have now begun offering the option of online investment in direct plans. Hence, dealing directly with the AMC need not involve any inconvenience or additional formalities.  

Smart Choice: Direct Plan

Related: How Debt and Mutual Funds Differ in Risk

  1. Investment Advice

No AMC is likely to recommend the mutual fund plans of another mutual fund company. So, it is possible that you will receive partial and biased investment advice from the seller of the direct plan.

Distributors of different regular plans offered by different companies can provide better investment assistance. This is a significant factor to consider, unless you plan on managing your investment, including rebalancing the portfolio, averaging the investment, cutting losses, and other tasks, on your own.

If your idea of MF investment involves receiving assistance in comparing different plans, along with continuous assistance with regard to your strategy, then a regular plan may be preferable to a direct plan.

Smart Choice: Regular Plan

Related: ULIPs vs Mutual Funds

  1. Additional Costs

The farmer may sell the rice to you at a much lower price. However, cleaning, packaging, storage and other such tasks are your responsibility. If you are not a mutual funds expert, then you may have to hire the services of Registered Investment Advisors. The RIAs will assist you in creating the right investment plan with its execution being your responsibility.

Since these services are covered by the commission paid by the AMC to the distributor, you do not pay extra when buying a regular plan.

Smart Choice: Regular Plan

Closing thoughts

As you can see, there is no absolute answer to the Direct or Regular mutual fund question. It depends on your investment skills, the extent of technical assistance required, your investment goals, impact of expense ratio on returns, and other factors.

 
 
 

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