Direct vs Regular Mutual funds

Direct vs Regular

Earlier AMCs where giving same returns for funds invested via intermediaries or middlemen and those invested directly. Some years back SEBI brought in rule to separate each fund into two options Regular and Direct option.

These changes were made to help those investors who invest their funds directly with AMCs without an intermediary. Logically they should be given better returns as there is no distributor commission involved compared to those going buying via brokers.

So the first question has to be which type of fund is better? After reading the previous paragraph, you already know the answer. Yes, direct funds are always better as you get a better return. You should always invest in direct funds. I always advise my clients if they know how to invest themselves they should opt for direct funds.

So why will someone invest in a regular mutual fund or via an intermediary?

You should invest via an intermediary in a mutual fund if you don’t have the right knowledge about mutual funds. There are thousands of funds out there and less than 5% of them will be suited to your needs. You need to sit with an intermediary and discuss your goal plans and they will guide you to select the best mutual funds suited to your needs.

I have seen cases where novice investors check out some sites like moneycontrol.com, even my favourite, and invest in the highest performing fund without knowing whether that fund is suited to them. Also, they don’t realize the basic math that the fund that performed relatively well in short term will have its 1yr 3yr 5yr rating ahead of others. They don’t care to check the basic figures like standard deviation, Beta or Sharpe ratio. Yes, you have to know that when you are investing for a longer duration to achieve your dreams.

Some even end up with negative returns just trying to save themselves from paying a minor cost to the intermediary. All this happens because of mismanagement, excess diversification, improper funds and folios in their portfolio delivering sub-standard returns.

Consider it the same as we are learning to play the piano and there is a teacher to guide us and suggest improvements. I believe there should always be a 3rd person reviewing our portfolio performances.

What are the types of intermediaries?

There are two types of intermediaries. I’ll try to keep it simple. RIAs are the one who guides you in selecting funds and charges you for each session. They sit with you and help you plan and also help you with quarterly and half-yearly reviews. RIAs sell you only direct funds. An experienced planner may charge you anywhere around 2k-5k per session. However, only one drawback is that their charges are irrespective of the fund performance. Let’s look at the advantages. Suppose you do the planning yourself and generate a 6% return over 10 years. Compare that with a case where an RIA comes up with some suggestions and you manage to get 10% return at nominal fees. Which one would you choose?

The other kind is the mutual fund distributor. They earn a commission for your investments from AMCs. They can’t charge you money directly. The problem here is some distributors may be registered to sell products from just only 1 or 2 AMCs which may be a drawback for you. However, others are authorized to sell funds from all the companies and give you unbiased services. Since the commissions are paid on the final value, they always suggest you the best funds as the fund performance determines their commission. However, as per SEBI guidelines, distributors are qualified to sell mutual fund but not to advise. Yeah its a bit weird.

How much does a distributor earn?

Due to SEBI restrictions on max expense ratio, the commission is mostly in the range of 0.05% to 1%. I’ll give you an example.

Suppose you have invested for 1lakh in a fund for 1year and that fund gives a commission of 1% then the agent makes 1000/- a year provided you don’t withdraw the amount within a year. Now had the invested amount has grown to 2lakhs the same agent would make 2000/- however on the other hand if the invested value has come down to just 50k then he will get just 500/-. So I kind of find distributor sold mutual fund as a better option as they work hard to generate that extra money for you for his benefit.

How about an online fund selection tool?

AMFI guides us to use a questionnaire for risk analysis and then suggest funds based on client goals. This can easily be achieved online. They work on a fixed algorithm, but I found it failing on many fronts. Like when I am sellings funds, I do a check on the family background myself which is an important factor in risk analysis.

When you are building a financial plan for your next 30-50 years you need to analyze your assets and liabilities. There should be a real human who should guide you and perform your quarterly and half-yearly reviews face to face.

You can use any online mutual fund platform but ensure you are only availing their premium service. Most free online investment platform has a paid advisory service also that helps you plan your investments. Those funds might be completely different from what you see on their website. So don’t go for free option anywhere if you lack the knowledge.

So I leave it to the readers to select how they want to invest.

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