- Date : 09/01/2021
- Read: 7 mins
A small fee can get you professional advice and safeguard you against uninformed decisions while investing in mutual funds.
Here is a question: would you rather invest in a fund where the commission payable is zero, fetches good returns, and is deemed as having done well for the investor – or would you go for a plan sold by bankers or insurance companies that come with high margin commission?
Before answering that question, a comparison between the two kinds of investments is in order. But before we dive in, let us understand the meaning of ‘zero commission’ in mutual fund statements. What exactly does it imply?
Zero commissions
In 2015, the mutual fund industry’s trade body AMFI (Association of Mutual Funds of India), put a cap on what fund houses can pay its distributors as upfront commission: 1% of the business they get.
So when you invest in a mutual fund, this is what the distributor pays – a percentage of your total net worth of assets under management (AUM). It is also the primary source of earning for a mutual fund distributor/agent.
The distributor is also paid a commission as long as you stay invested, which is called the trail fee. This is paid on an annual basis and will be paid even if you do not invest further – so long as your investment is not withdrawn.
The trail fee structure enables investors like you get a good fund selection as the agent’s business goes up only if the mutual fund does well and attracts more investors. For this, it is in the agent’s self-interest to give good advice to clients.
If an investor finds zero commissions against a scheme in their account statements, there is a good chance that the fund was launched before March 2015, when the AMFI cap came into play. Back then, the practice was to pay upfront commissions.
Then, in September 2018, the Securities and Exchange Board of India (SEBI) capped the maximum expense ratios a fund house could charge at 2%-2.5%, depending on the AUM. The burden came to be borne by the distributor.
What all this means is that while there’s no zero commission if investment is made via an agent, the investor is not really hurt by the commission; in fact, in the case of the trail fee, it helps the cause of investor.
Skipping brokerage
Is there any way you can invest in mutual fund schemes without paying a commission or brokerage to your agent with whom you maintain a demat account? Yes, this can be done, thanks to an innovation by SEBI called ‘direct plans’ in mutual funds.
A mutual fund manager can manage a regular plan and a direct plan together, making investments in the same assets for both options. With a regular plan the fund house pays a commission to the distributor or agent, but this is not the case with a direct plan.
SEBI introduced direct plans for mutual funds in 2012 specifically to enable investors to invest in mutual funds after bypassing any intermediary, thereby skipping commission payments.
If you want to invest in a mutual fund scheme without paying brokerage, you should look at buying that mutual fund’s direct plan at the branch office of the fund house, where you fill in the application form yourself, and not through an intermediary (agent).
You can buy direct plans by accessing them on the website of the asset management firm concerned, without having to pay any brokerage fee for the transaction. If you wish to avoid paper records, opt for online statements.
But at the same time, do remember there is a new crop of discount brokers such as Zerodha and 5paisa who offer direct mutual fund. You can access them as well,
Other differences
There are quite a few differences between the direct plan and regular plan when it comes to investing in a mutual fund. Knowing what these are can help you decide to what extent you should pitch for zero commissions when making an investment.
The first difference is, of course, related to the idea behind why SEBI introduced the direct plan: it does away with any third-party involvement (brokerage houses and agents). This is what makes it a ‘direct’ plan. With a regular plan, you have to route your transaction through an intermediary.
The second difference is an offshoot of the first: as no third party is involved with direct plans, it is ideal for those who can take investment calls on their own. This means they also have to do their own market research. (Please note: many regular investors prefer expert investment advice, based on market research by professionals, which makes regular plans suitable for them. Newbies are advised to take this route too.)
The third difference is also an offshoot of the first: as no additional fees have to be paid to a broker or agent in a direct plan, the return will be higher if you take this option to invest. How much of a difference this makes to you is something you can work out.
The fourth difference is similar to the third: as there are no agents or additional expenses by way of accompanying commissions involved with direct plans, you have an advantage – the expense ratio will be lower than that for regular plans.
The fifth difference is an effect of the previous point: since the expense ratio of a direct plan is lower than that of a regular plan, it also reports a higher NAV after considering all the expenses, when compared to a regular plan.
The direct edge
As can be seen from the comparison between regular plans and direct plans of mutual funds in the previous section, the former looks costlier, and this is mainly due to the commissions that are paid out to agents and fund managers.
However, these intermediaries also bring welcome insights into the financial markets, and are therefore more suited for new investors who seek financial advice. These professionals have a better understanding of a broad spectrum of mutual funds, which enables them to assess which mutual fund can be the right fit for a particular investor.
That aside, they also bring in convenience. Investing in a mutual fund is more complex than it looks; it requires the investor to identify a mutual fund that matches their risk profile and financial goals. Therefore, if you choose a direct plan, you have to find the time to monitor your portfolio on a regular basis.
On the other hand, if you opt for a regular plan, the intermediary will track the market, monitor your portfolio, and also advise you on restructuring it when required. What’s more, they provide value-added services, such as keeping a record of your investments and providing tax proof during tax filing. Such services are not available with direct plans.
Yes, there is the additional cost involved with regular plans, but given its small percentage in value terms (1%-2.5% of Rs 1 lakh in investments works out to Rs 1000-2500 in fees), the costs may be worth it. At least it guards you from taking uninformed decisions.
While regular plans seem to involve unnecessary expense by way of commissions, you have the cushion of having experts advise you on how your money should be invested.
Last words
At the end of the day, the issue is not whether a regular fund that requires you to pay commissions is worse than a direct mutual fund. The real issue is: does the plan you have opted for suit you or not?
If you are confident that you are a market-savvy investor who has the knowledge and time to select the best mutual fund, a direct mutual fund is perfect for you. Why pay an advisor in fees if they cannot add any value? However, if you need investment guidance (most newbie investors do), you need to go for a regular plan. You get professional advice, well-researched data, and a host of other services. Looking to invest in stocks? Here’s what you should know about discount brokers
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or legal advice. You should separately obtain independent advice when making decisions in these areas.
