Explained: Why Sebi wants mutual fund investors to switch to direct plans

WHAT ARE DIRECT AND REGULAR PLANS IN MUTUAL FUNDS?

Direct and regular plans are two ways of investing in a mutual fund scheme. In a direct plan, investors put money in a scheme without involving a distributor, broker or agent. Since no commission is paid, the scheme’s expense ratio or fee is lower.

A regular plan is bought through a distributor, broker or adviser. The mutual fund pays a commission to the intermediary, and this cost is recovered from the investor through the scheme’s expense ratio. As a result, the expense ratio is higher than that of direct plans.

According to the latest AMFI data, the total expense ratio (TER) of regular plans ranges from 0.36% to 4.3%, compared with 0% to 2.7% for direct plans.

WHAT HAS SEBI CHANGED AND WHY?

From November 1, Sebi has asked mutual fund houses to make direct plans the default option on their websites and mobile apps. So, if an investor visits a fund house’s app to invest in an equity scheme, the direct plan will now be pre-selected or displayed as the primary option. Investors can still choose regular plans if they want distributor assistance.

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BUT WHAT’S WRONG WITH REGULAR PLANS?

There is nothing wrong per se with regular plans. In fact, it may be suitable for investors seeking professional guidance or those new to mutual funds. After all, distributors handle the client portfolios and do periodic reviews of the holdings.But, critics point out that in addition to the higher costs, regular plans could result in conflict of interest. Since distributors are paid commissions by fund houses, this would push some intermediaries to recommend schemes that offer higher commissions rather than those best suited for client needs. They claim investors would be better off availing the services of fee-based financial advisers, who charge investors directly for their advice.

HOW MUCH MONEY CAN INVESTORS SAVE THROUGH LOWER EXPENSE RATIOS?

While the difference in the total expense ratio may appear small, it can significantly impact returns over long investment horizons.

For instance, an investor putting Rs 20,000 a month into an equity mutual fund for 15 years, assuming annual returns of 12%, could accumulate around Rs 94.4 lakh in a direct plan with a 0.7% expense ratio. In comparison, the corpus would be about Rs 86 lakh in a regular plan with a 1.7% expense ratio.

The difference arises because lower expenses leave more money invested, allowing returns to compound over time.

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WHO SHOULD CONSIDER DIRECT PLANS?

Direct plans are suitable for investors who can research funds, monitor their portfolios and make investment decisions independently or with the help of fee-based advisors.

If you understand concepts such as asset allocation, risk management and portfolio rebalancing, and can stay invested through market cycles, a direct plan may be a good option.

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