Once I was asked by one of my clients that his friend gets free of cost investment advice & financial plan from a broker. I asked my client, “Being a surgeon, do you operate your patients without fees?” Again I asked him, “If you do so, how will you be compensated?” I briefed him the concept of Regular Plan vs Direct Plan & insights into Financial Plan. He then smiled and said, “I understand.”
While you invest in Mutual Funds, you have two options. You may prefer either Regular Plan or Direct Plan of Mutual Fund schemes. There is no other characteristic difference between Regular Plan & Direct Plan, except expense ratio. You need to understand the delineation of Regular Plan vs Direct Plan in Mutual Fund before you start investing. Hire a professional for proper unbiased guidance.
Securities and Exchange Board of India (SEBI) came out with many amendments in Mutual Fund industry in September 2012. They launched Direct Plans of Mutual Fund schemes. Investors can invest directly with the Asset Management Co. (AMC) in Direct Mutual Funds without paying any commission to distributors. This is what is called “Do It Yourself” i.e. “DIY”. Direct Plan option is given to an investor to purchase/subscribe units of a scheme directly with the fund and not through a distributor w.e.f 1st Jan 2013. Alternatively an investor can invest in Direct Plans of Mutual Fund schemes after seeking advisory services against a fee from a SEBI Registered Investment Advisor.
What is expense ratio in a Mutual Fund scheme?
It’s per unit cost of management of mutual fund charged by the Asset Management Company. These costs include expenses for fund management, administration, advertising and paying sales commissions to mutual fund distributors (operating expenses). The returns of all Mutual Fund Schemes are calculated on the Net Asset Value and the expenses are deducted from the investor’s fund on daily basis before the calculation of Net Asset Value.
Who is Mutual Fund Distributor?
A distributor is an individual or an entity who helps an investor to buy and sell units of Mutual Fund schemes. A distributor earns upfront and trail commission for boarding investors into the Mutual Fund investments.
Duties and Responsibilities of a Mutual Fund Distributor
A Mutual Fund Distributor makes an investor aware of various schemes of Mutual Funds and their features.
A distributor helps an investor to carry out transactions like buying, switching, and redemption and also show the performance of their investments.
Regular Plan vs Direct Plan in Mutual Funds
There is a long argument and controversy regarding Regular Plan vs Direct Plan. The expense ratio of Direct Plans is lower than Regular Plan. Therefore, the Net Asset Value of Direct Plan is higher than Regular Plan as there are no distribution expenses in a Direct Plan. Thus, it is commission-free. Therefore, there would be no distribution and trail fees paid to distributor. As the expense ratio is low, the returns are also higher than Regular Plan.
Who pay commission to broker?
Asset Management Companies pay the brokerage/commission to investors’ broker/ distributor. An investor pays the commissions indirectly. The commission comes out of investor’s investment. The Net Asset Value (NAV) for a Mutual Fund scheme is calculated after all expenses. NAV is post of all expenses including commission & liabilities.
A trail commission depends on the value of the investment for each year if the investor’s money remains invested with the fund of the AMC. Apart from trail commission brokers get upfront commission from the fresh/new investments.
Commission is a hidden/concealed cost that investors bear. Neither investors write a separate cheque nor investors get any invoice for the hidden cost. The brokers or the distributors is compensated by investors indirectly. I have given an illustration below in this article for your better understanding.
After evaluating Regular Plan vs Direct Plan, even when you hire an Investment Advisor for a fee and invest in Direct Plan of Mutual Fund schemes, you’ll be better off in the long run.
Scope of work of a SEBI Registered Investment Advisor (SEBI RIA)
There is a difference between a Distributor and an Advisor. SEBI RIAs have license from the regulator to practice as an Investment Advisor. Advisors are like lawyers, doctors and architects etc in the society. Those who need investment advice or financial plan can always contact a SEBI RIA. Investors get unbiased advice/solution. A SEBI RIA is never driven by any sorts of commission-able products as he will work in fiduciary capacity against a fee.
Apart from investment advice, an investor may approach to a SEBI RIA for financial plan before s/he starts investment. Financial Plan helps an investor to identify the goal amount before s/he invests.
Duties & responsibilities of a SEBI RIA
While providing investment advice, a SEBI RIA needs to consider the following:
- Objective of investment;
- Understanding of qualitative & quantitative inputs;
- Evaluate cash flow;
- Opportunity cost;
- Investment priority;
- Time horizon of investment;
- Risk tolerance & risk taking capacity of client;
- Surplus for investment;
- Debt planning & repayment of debt;
- Asset allocation as per risk profile & investment time horizon;
- Goal based portfolio & progress;
- Financial Plan & periodical review of financial plan if required;
- Management of investors’ behavior & expectation; &
- Work with due diligence and conflict-free advice etc.
You may engage a SEBI RIA if you’re too busy and have limited knowledge and information to manage your personal finance. The SEBI RIA can give unbiased solutions with due diligence. His/her scope of work is not limited to distribution of mutual fund product. He can professionally guide you. He’ll make a financial plan & recommend solutions as per your product suitability as products are commission free. The scope of work of a SEBI RIA is much wider than a distributor.
SEBI’s intention is to keep separate distribution from advice. Distributors can’t advise his customers and they are not allowed to make any investment advice or financial planning too. A distributor can’t accept any advisory fee as he gets commission by selling mutual fund products by manufacturers (AMCs) which you bear indirectly & who doesn’t have licence from regulator. On the other hand, a SEBI RIA is not allowed to earn commission form a product manufacturer as he’s compensated by fee directly borne by his clients. It’s like a doctor & a medicine seller.
Nothing is free of cost whether an investor buys from a distributor or engages a SEBI RIA. Now the question is “how much cost”, unless an investor goes for “DIY” (Do It Yourself).
Cost analysis in comparing Regular Plan vs Direct Plan
NAV on April 20, 2018 for Aditya Birla Sun Life Frontline Equity Fund (Growth) for both Regular Plan & Direct Plan:
Scheme Name & Plan NAV Expense
ABSL Frontline Equity Fund (Growth) Regular 217.55 2.21 (As on 31/03/2018)
ABSL Frontline Equity Fund (Growth) Direct 228.62 1.10 (As on 31/03/2018)
The NAV of Direct Plan is higher than Regular Plan as the expense of Direct Plan is lower. The reason is Direct Plans are “no commission product”.
Now if an investor invested on April 20, 2017 at what price did he buy?
NAV on April 20, 2017 for Aditya Birla Sun Life Frontline Equity Fund (Growth) for both Regular Plan & Direct Plan:
Scheme Name & Plan NAV
ABSL Frontline Equity Fund (Growth) Regular 193.72
ABSL Frontline Equity Fund (Growth) Direct 201.30
Suppose an investor invests Rs. 10, 00,000 on April, 20 2017:
In regular plan the investor gets 5,162.09 units.
In direct plan the investor gets 4,967.71 units.
Suppose he sells on 20 April, 2018:
In regular plan the investor gets Rs. 11, 23,230.12.60 (5,162.09*217.55).
In direct plan the investor gets Rs. 11, 35,717.83 (4,967.71* 228.62).
Therefore, the difference is Rs. 12,705.23.
After evaluating Regular Plan vs Direct Plan, you have the following options
- You may invest through a Distributor or Salesperson or
- You may opt for “DIY” or
- Hire a SEBI RIA.
How you can offset?
While you engage a SEBI RIA for a fee and if you analyze the cost, it may be almost at par with the indirect cost of investing through Distributor/Salesperson. Why there is a difference in Regular Plan vs Direct Plan? In Regular Plan, you don’t pay up-front, but expenses are adjusted from the NAV. The NAV which you see daily is calculated after deducting these expenses. As I mentioned earlier, suppose in Regular Plan an investor bears Rs. 2.21 as expenses and in Direct Plan he bears Rs. 1.10, an investor can save Rs. 1.11. It varies from fund to fund. A SEBI RIA always recommends you Direct Plans. His scope of work is much wider than a Distributor. Even when you hire a SEBI RIA for a fee, you may be bearing lesser cost in the long run than the cost you would bear if you invest through a distributor.
If you’re well informed and have investment acumen then go for “DIY”. If you’ve time and research about mutual fund investments may invest by your own in Direct Plans, “DIY”, rather than buying them through a Distributor or Salesperson. Although there is a long controversy in Regular Plan vs Direct Plan, you have to understand your limitations and opportunities. Therefore, if you have limitations (lack of knowledge of asset allocation, emotional behavior, risk profile, research, time constraint etc.). Secondly, you may need ongoing monitoring to ensure you that investments are performing as per your goals which may change with time. You can offset your limitations by hiring a SEBI RIA . Of course an Advisor may be reluctant to work with you if he’s not compensated properly.
You can see the uniqueness & scope of work of a distributor and a SEBI RIA. Accordingly, you can engage a service provider as per your requirements. Otherwise, you may go for “DIY.”
If you need professional support, then whom to choose?
The role and scope of work of SEBI RIA is extensive & research oriented. Engaging a SEBI RIA for a fee and following a financial plan instead of investing through a distributor is a trade-off you’re willing to make to arrive at sound financial situation.
Ultimately, you need financial freedom. Hence, it’s better not to follow others as your requirements and objectives are different.