Invest in Direct Plan option of mutual funds

The Securities and Exchange Board of India (SEBI) has announced some changes in the mutual fund sector. Among the changes, the most beneficial for investors is the Direct Plan route which will be offered from 1^st January. 2013.

What is a Direct Plan?

At present, you can avail the services of an agent/broker while investing in the fund. You can also invest directly in the scheme, if you approach the fund directly in person or through online. But in all the cases, you are getting the same NAV for the scheme. If you invest without an agent, the savings in commission and other expenses will go to the fund house.

Good news for investors! From 1^st January. 2013, there will be a direct plan option, where the charges will be lower than the normal plan and you will benefit by it. The indications are that there will be reduction in annual charges of around 0.75% in equity funds and around 0.5% in debt funds. Over long term, this can make big difference in your investments.

How to select a good fund?

Yes, you will get higher return on your investments, if the charges are less. But your selection of this option depends on many factors.

At present there are around 3500 mutual funds schemes available in India for an investor. If you compare the performance of these schemes, there is lot of difference in their performance.

The top performing fund in the diversified equity category has given a CAGR of around 26%, while the worst performer has given around 10% in the last 10 year period! Your investment of 1000/- in the best fund would have become 10,000 now, while the worst performer would have given you just 2500. Huge difference!

Will the same fund continues to deliver the superior retuns over long term?

Not necessary. We have so many examples in the recent past, where super performing funds start underperforming. In such a situation, how can we invest in a fund for long term goals?

We must monitor the performance and change the funds, if necessary on a half yearly basis.

Other factors to watch while selecting the funds

You may have started investing in an equity fund for funding your daughter’s marriage. As you are approaching the goal, you should reduce the equity allocation and increase the debt component. It is very important in investments. Another important aspect to consider is the asset allocation. If the equity perform very well and change your asset allocation, you have to rebalance the portfolio, by switching from equity to debt. Don’t invest blindly listening to the tips given by friends. Each individual’s financial goals are different and this requires different instruments. Going by the Star ratings alone is not a good idea, in this era of paid news. Change of fund manager, takeover of the fund house etc will be common now. All these will have an impact on your investment.

What an investor should do?

You should invest in a mix of 5-6 mutual funds, as per your risk profile. It is recommended to go for goal based investment, after quantifying your financial goals. This will ensure that you reach your goals safely. The allocation towards equity will be more in the initial years but has to be reduced as you nearer the goals.

Effect of expense ratio on your mutual fund investment

If your investment is for1-2 years, the effect of expense ratio will be negligible. But on a long term, it will make huge difference. Let us assume a fund which offers return of 12% CAGR before factoring the expense ratio. Let us see how your investment of 1 Lakh will perform in this fund for the 20 years under different expense ratios.

At 1% expense ratio, your 1 Lakh will be 788977 after 20 years, but if the expense ratio is 2%, your accumulation will be 643994 only. Your money is reduced by 144983 or 18%, just with 1% increase in expense ratio!

Now, you can decide, how much you can save by opting for a Direct Plan, with lower expense ratio. It will have huge impact on your long term financial goals. If you are saving through equity mutual funds for various goals, SIPs in direct plans will be a better idea.

Will you go for the Direct Plan?

If you are fully aware of the investment spectrum and have a good idea about all the funds available in the market and if you can spend that much time to research on these and take timely decisions, you can go for the direct plan option. But, if you invest in a poor performing fund, you may go wrong.

It is better to invest, as per the recommendation of an independent advisor, who is not having sales targets. After getting an independent advice regarding the fund to invest, you can go for the direct plan option and save huge money in the long term.

It is equally important to review the fund performance and change the fund if necessary. But if you have an independent financial planner, he will do it for you.