Mutual Funds are a great way to invest and diversify your equity portfolio without having to bear the headaches of tracking stocks individually. They however come with a cost of managing this, and many times these additional expenses are trivilized. If you want to make every penny of your investment work, there are certain details you should not be ignoring. This post could help you make some informed decisions on Mutual Fund picking so that your gains are not getting truncated in the long run.
Before we get to the rules of funds, let us do a quick calculation. Imagine you have INR 100,000 invested. What would the difference in gains for a yearly gain of 7% versus 7.4% over say 10 years? One might feel a 0.4% is too small an amount in the bigger scheme of things, but we ignore the key science of compounding which comes into play here! In reality, this 0.4% makes a difference of close to 8% of absolute gains over that period. And this is what is exactly happening in your Mutual Fund investments without you paying close attention. Some amount of your corpus could be leaking!
Different layers of expenses pile up. Every Mutual Fund scheme has 2 plans – Direct and Regular Plan. Every Mutual Fund company publishes a TER (Total Expense Ratio) which is charged to the investors. This TER is charged as a percentage (this is an important factor!) of the investor’s corpus and essentially includes the management and other costs for maintaining your fund investment. For Regular Plans, there is an additional Distribution Cost that is paid to the intermediary between the AMC and the investor who assisted in the transaction. These are essentially your online brokerage. Think of it as you going to an ICICIDirect demat account and investing funds. This additional cost can run anywhere close to 0.5 to 1.0%. When you invest in a Regular Plan Mutual Fund, the TER is accounted for in the NAV, so you effectively end up getting lesser units of the funds. Over some time, even this small fraction gets compounded into an amount that you can’t just ignore.
Direct Plans are brought directly from the AMC site. For every fund you buy directly, you would see some Distributor information like this during the purchase which is best left blank.
Direct Plans are DYI (Do It Yourself) path. You have done your research and directly invested through the AMC site. In recent years it has become sufficiently easy to invest through this route. In short, you need to Create a Login in AMC Site -> Complete your KYC, and you are set!
Another important point that often investors fail to notice is that the TER is an annual cost. Yeah, you heard it right! It is not a one-time transaction cost. Even if the fund that you invested in is underperforming, the fund house still pockets this amount, and your overall corpus value depreciates. Hence, it is very important to compare the TERs across similar funds and choose wisely.
Passive funds (such as Index Funds) have extremely low expense ratios compared to actively managed funds. I have written a separate post on Index Funds here where you can check out the benefits.
Beyond TER, you should also keep track of the Entry and Exit load of the fund. The majority of funds have an Exit load, which is a charge levied if you redeem your invested units within a specific duration.
So plan your investment horizon to avoid these additional cuts to your corpus.
Even though this post suggests going via the Direct Plan route to save on the expense cost, more often investors find it convenient to go via demat account routes such as ICICIDirect, and HDFC Securities to have a single place to view and manage their investments across multiple AMCs. This is very much a solvable problem even when you go through separate AMC registrations and direct investments. CAMS provides a platform to view your aggregated portfolio across different AMC folios. Similarly, QUANT provides a similar medium to aggregate your folios. For this, you need to register and create an eCAN number which serves as the central identity. Both CAMS and QUANT over the years have onboarded the majority of the large AMCs. So leaving aside some one-off AMCs, you would find all popular AMCs registered under it.
To summarize, do not underestimate the compounding effect of these expenses, especially when you are a long-term investor. After all, a penny saved is a penny earned!
