How direct mutual funds can help you meet your personal or family goals

Goal oriented financial planning has become increasingly important over the years. With the cost of living having gone up and a plethora of life milestone requirements dependent on one or two income sources, it is essential that people plan their requirements well in advance. One product that the financial market offers which can meet this aim is mutual funds.

A long term product, mutual funds help investors spread their portfolio across assets classes like equity, fixed income, bullion, and commodities by making use of different investment strategies and also facilitate investment overseas via fund of funds.

But among mutual fund schemes themselves, there are two investment options offered: regular plan and direct plan.

Let’s look at what direct plan is and how it differs from the regular plan.

Direct investments in mutual funds

The capital markets regulator SEBI (Securities and Exchange Board of India) had released a circular in September 2012 directing AMCs (Asset Management Companies) to offer direct investments into their mutual fund schemes via a separate option in all new and existing schemes. Following this order, fund companies began offering direct plans, in addition to regular ones, since January 2013.

As their name suggests, direct options or plans offer a mode of investing with an AMC directly instead of through a distributor or financial advisor. Since this additional layer of professional advice is removed from the process of facilitating mutual fund sales, direct plans are cheaper than their regular counterparts and thus have lower expense ratios. No commissions are paid out of these plans, thus making them the low cost alternative to regular plans. They also have a separate Net Asset Value (NAV).

It is important to note that direct plans are just a mode of investment and not a different scheme from regular plans. The underlying portfolio remains the same regardless of which mode an investor chooses.

Direct plans were aimed at those investors who are aware of mutual fund investments and know which schemes are suitable for them. Since these investors were accustomed to investing based on their own research and without the help of any professional advice, it did not seem appropriate to charge them the same expenses that were charged to those who sought help of financial advisors, wealth managers and others. However, the use of direct plans is not restricted to a certain segment – it is available to all. Investors can invest in these plans either at the nearest AMC or a fund registrar’s office or online.

If we compare direct and regular plans, in the former you need to do your own research or have access to reports based on which you can decide which funds suits you best while in the latter you get the help of a relationship manager or investment advisor in selecting the right funds for your goals. While in direct plans, you need to execute your buy and sell transactions either in person or online, a distributor or agent does this for you when you invest via a regular plan.

How direct plans can help you achieve goals

Achieving financial goals is dependent on two factors:

• The actual return on the investments
• The associated cost of making those investments

While no investor or professional can gauge or guarantee the return on any investment, they can certainly control the cost of making the investment.

In order to show how costs affect your wealth and how direct mutual funds can help you achieve your personal or family financial goals, let’s look at the following example:

Let’s consider that you start with an initial investment of Rs 1 lakh. The rate of growth is 10% per year. Also, a fee of 1% is charged per year from the amount that is accumulated at the end of the year. For a 10 year period, the following table will result:

The last column shows the amount accumulated without any fee.

You can see that if no fee would have been deducted, then your Rs 1 lakh investment would grow to Rs 2.59 lakhs at the end of 10 years at the rate of 10% per year. However, just a 1% fee means that the corpus is reduced to Rs 2.34 lakhs – a difference of nearly Rs 25,000! Do remember that a 1% fee is quite modest.

Now, if the fee was to increase to 1.5%, the end period amount would decline to Rs 2.23 lakhs, and at a 2% fee, it would further fall to Rs 2.12 lakh. The difference between the no cost corpus and that at 1.5% and 2% fee is Rs 36,382 and Rs 47,447 respectively. The difference between the 1.5% and 2% case corpuses is Rs 11,064, that between the 1% and 1.5% fee cases is Rs 11,581, and between the 1% and 2% fee cases is Rs 22,646. And this is the situation when we’re considering only Rs 1 lakh as the starting investment, that too only for a decade. For Rs 10 lakhs, all the aforementioned amounts and differences can be multiplied by 10.

The charged fee results in a change in the annualized returns. For the no fee case, the annualized return or Compound Annual Growth Rate (CAGR) would remain 10%. However, for the 1% fee case, the CAGR would decline to 8.9%, for 1.5%, it would be 8.35%, and for 2%, it would stand substantially lower at 7.8%.

At these rates, if you were to remain invested for 20 and 30 years (with the initial investment being Rs 1 lakh), the following amounts would result:

Since the difference between the expense ratios charged on regular and direct plans can stretch to 0.50% and above, you can see how direct plans can positively impact your corpus.

Given that you would have goals spanning from five years going up to two or three decades, choosing direct mutual funds online can help you achieve those goals more efficiently by saving cost. Even if the return on your investment were to undergo some drop, the lower cost of investing in these plans would help boost your wealth and make you successful in realizing your investment objectives.