Pros And Cons Of Direct Investments In Mutual Funds

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Mutual Funds are popular investment instruments that help build long-term wealth. They can offer inflation-beating returns in the long run and their diversified portfolio structure ensures returns generated are risk-adjusted as well.

You can invest in mutual fund schemes either through a ‘regular’ way where fund managers or distributors charge some fees to take your investment calls or through direct investment which costs less and offers better returns.

Direct investing in mutual fund schemes eliminates the intermediary (in this case the distributors) and investors can directly invest with the fund house without any help from distributors. It looks beneficial for the investor as direct investing reduces the expense fees — charges levied by fund houses for managing assets. However, direct investing is not an easy game and an investor needs to be well versed with mutual funds and the securities market to avoid serious loss of value.

Here are some of the advantages and disadvantages of direct investing in mutual funds to help you make an informed choice.

Pros:

Low Expense: Expense ratio is the fees charged by a scheme from investors for managing their investments. Typically, for regular equity-oriented schemes, it ranges from 1 per cent to 2.5% of the assets under management. For regular debt schemes, the expense ratio ranges from as low as 0.05% to 0.6 %. Regular schemes are done through intermediaries. For instance, if your investment value in a regular equity fund is Rs. 1,000, you might have to shell out Rs. 10 to Rs 25 as fees. However, in direct schemes, the expense is reduced by as much as 1.5% for an equity scheme. It means if a regular scheme is charging 2.5% to investors, investments done in the same scheme through direct mode will be charged 1%, thus cutting down the investors’ cost and ensuring higher returns more funds are invested in the scheme on the behalf of investors.

Higher Returns: As the cost to investors is lesser in the direct mode of investments in mutual funds since there is no distributor involved, more funds are invested in the underlying portfolio. This results in better returns for investors in the long run. It is seen that direct schemes tend to generate 1-1.5% more return for investors compared to regular investment. Though 1-1.5% more return may look minuscule, there is a substantial difference in wealth creation as the tenure increases. For instance, a SIP of Rs. 1,000 in a regular equity scheme with an expense ratio of 1.58% would have made Rs. 60,000 of investments in the last five years into Rs. 1,04,106. Direct investment in the same scheme with a similar SIP amount with an expense ratio of 0.46% would have created a value worth Rs. 1,07,871. This gap may be short in the short-term but could protract into a significant gap worth tens of lakhs over a very long tenure.

Cons: 

In terms of performance and fees, direct investments are better. Direct investing in mutual funds have only advantages provided the investor is tech-savvy, knowledgeable about the market condition and understands how mutual funds work. Lack of knowledge tends to make direct mutual fund investors commit mistakes. While direct investments are better to earn higher returns, they may not be an appropriate choice for everyone, especially for those who are new to the markets. Such investors should stay away from the common mistakes discussed below.

Mistakes In Selecting Schemes: There are several mutual fund schemes offered by various fund houses in India. It’s not an easy task to zero in on the suitable schemes. Often, investors end choose schemes for past performance without taking into consideration future expected performance. This way they end up investing in yesterday’s winners and thereby lose out on the potential return which could otherwise have been made if other schemes were picked for investment.

Decision Making: Depending on the market condition, investment portfolios need to be reviewed and suitable alterations need to be made at regular intervals. However, it is generally witnessed that direct investors fail to take the right decision at various stages of the investment tenure. For instance, some situations warrant partial withdrawal of funds, purchase additional units when markets crack, switch to other schemes, you need not panic at every correction, among others. Often, the inability to take such investment decisions hits the wealth creation journey of investors.

Biases: Direct investors tend to develop certain biases which eventually lead to bad investment portfolios. The concentration of similar kinds of funds or funds one has developed a liking for without getting into basics is a normal phenomenon among direct mutual fund investors. Biased investment decisions neglect the asset allocation basics which could turn riskier.

Conclusion

Direct investments in mutual funds are always beneficial provided investors understand the basics of investment. However, mistakes done in investment decision making may negate the advantage of low fees as bad compounding returns. Just the fact that direct investing fees are lower shouldn’t be the only reason to rush in. A piece of good advice from a fund manager can prevent you from picking an unsuitable scheme and help you unleash your potential for wealth creation. A poor decision may derail your financial planning journey.

The writer is CEO, BankBazaar.com, an online marketplace for loans, credit cards and more.