Once you’ve decided exactly which mutual funds to invest in, you actually need to make it happen. How you invest in mutual funds also determines what it costs you and hence we’ve kept the two topics together.
There are broadly 2 ways to invest in mutual funds.
- One is to go through a distributor or advisor; and
- Second is to approach the mutual fund companies directly.
Option 1: Investing through a distributor or advisor
A distributor or advisor will provide you assistance with selecting a fund and with actually making the investment. For this service, they earn a commission or a fee. The primary difference between an advisor and a distributor is how they earn their fee – directly from you or indirectly.
An advisor charges you an Advisory Fee that is mutually negotiated and agreed between the advisor and you. The fee may be related to the investments you make or be fixed fees for the financial planning and other advice that the advisor provides.
A distributor, on the other hand, earns a Commission from the mutual fund company – usually between 0.5% to 1%. This is indirectly paid by you as part of the expense ratio. Recognizing that this amount is usually very small, SEBI also permits the distributor to charge a transaction charge of Rs 100 to the customer.
Before 2014, an advisor could charge you a fee as well as get paid a commission by the mutual fund company. This practice has been banned by SEBI and every entity that collects mutual fund investments must choose whether it is an advisor or a distributor and get paid only once.
How does the mutual fund company know whether or not to pay a commission to the advisor/ distributor?
Since 2013, every mutual fund company offers what is called a “Direct Plan” for every mutual fund scheme. Investments through these plans do not earn commission. As a result, these plans also have a lower expense ratio (by about 0.5%). An advisor is required to channel your investments through a “Direct Plan” whereas a distributor channels your investments through a “regular Plan”
Option 2: Investing directly with the mutual fund house
All mutual fund companies provide a way for you to invest directly by approaching their office or online. This had no advantage for an investor until the introduction of the Direct Plan.
Now investors can approach a mutual fund company directly and invest in the “Direct Plan”. You can do this in 2 ways. (i) Visit the office of the AMC or their appointed RTA (CAMS, Karvy etc) and submit a form along with your PAN Card copy and cheque (ii) sign up online with each of the AMCs that you wish to invest in and invest online using a payment gateway.
How do the two options compare?
Currently Direct plans of equity mutual funds have expense ratios that are typically 0.4-0.5% lower. This means that your return by opting for the Direct plan is higher by that amount. What does this mean in actual money? For example: If you invested Rs 100 for 10 years in equity mutual funds, you could expect to have Rs 370 in a direct plan vs Rs 354 in a regular plan. This assumes a 14% annualised return for Direct plan and a lower 13.5% return for the Regular plan. The addition of Rs 16 over 10 years is what you make by taking the direct option.
Why would you want to invest in a regular plan through a distributor or advisor?
This is a matter of great debate and the two perspectives on this are as follows: (Disclaimer: Scripbox, the provider of this course, is a distributor)
Distributors and advisors provide a useful service in
– helping you determine which investment options are right for you
– helping you analyse and understand these investment options
– selecting specific funds to put your money into without any commission induced bias
– facilitating the investment or withdrawal
– help you track and monitor your investment
– recommend changes as and when required
– help you take the right exit decisions after considering tax and other costs
– help you follow a disciplined investing process
You could do all of the above on your own by learning about mutual funds and spending the requisite time and effort. You must then follow a disciplined process of investing and get the extra return.
In a way, you are paying your distributor or advisor, an indirect fee for the service they provide. This is similar to the fee you pay your doctor, lawyer or other professional for providing their services in an area you may not be most competent in.
Before deciding whether to invest directly or through a distributor/advisor, you must evaluate whether or not
- Your distributor is providing you valuable services for the fees you pay them. Use the checklist above and ask them the question.
- Whether you need the extra help from them. Their advice and guidance may be more valuable than the 0.5% saving. This could come in the form of extra return earned on better recommendation or saved costs. Also, your own time may simply be worth much more than what you pay them.