I want to invest Rs 1 lakh in mutual funds. My broker told me that it would be better if I invested directly but didn’t explain why. Will there be a difference in my returns if I invest directly?
— Pavan Kumar, Udaipur
Your broker is correct. In most cases it is better to invest directly in a mutual fund than to do so through a broker. Every time you invest in an equity mutual fund you pay an entry load of between 2% and 2.5% of the invested amount. Fund houses pass on this fee as commission to distributors— agents, brokers or banks through whom investors normally route their applications.
The rationale for charging entry load is simple: a distributor spends resources to educate the investor and rope in investment, so he should be paid for his services. Till last year, even if you didn’t route your application through a broker and invested directly, you were charged the entry load.
How entry load matters (on an investment of Rs 1 lakh) | |||
| Through Broker | Direct | Extra Returns | |
| Entry load (%) | 2.5 | Nil | - |
| Amount that is invested after entry load | 97,561 | 1,00,000 | 2,439 |
| Value after 1 year | 1,12,195 | 1,15,000 | 2,805 |
| After 5 years | 1,96,230 | 2,01,136 | 4,906 |
| After 10 years | 3,94,689 | 4,04,556 | 9,867 |
| All figures except entry loads are in Rs; Returns are assumed to be 15% per annum | |||
From January this year, the Securities and Exchange Board of India (Sebi) has made a new rule according to which direct investments in mutual funds will not be charged any entry load. Online investments too are eligible for a waiver if not routed through a brokerage. A 2-2.5% entry load may seem small but it can impact your returns in the long term. If you invest Rs 1 lakh, the difference could be more than Rs 10,000 over a 10-year period.
Till last year, few investors bothered about entry loads because the returns from equity-based funds were so huge. In rising markets, the losses of returns due to entry loads were hardly visible, but in falling markets loads would add to the losses.
But the days of phenomenal returns are now behind us. So a 2.5% load will pinch more. Most fund houses offer online facilities, but an investor has to visit the fund office or investment centre to make the first investment and submit documents such as a copy of PAN card to meet the KYC norms. After he is allotted a password, he can invest online.
Sebi’s move has certainly brought down the costs for investors, but more needs to be done. Apart from the entry load, investors are charged an annual fund management fee. Known as expense ratio, this can vary from 1.5% to 2.5%. A part of this fee is used to pay a trailing commission to the broker.
There is no difference in the expense ratio charged whether you invest directly or through a broker. Logically, if the investment is direct and no trailing commission is paid, the expense ratio should be lower. This would further boost the returns for investors who take the direct route to investing.
However, if the distributor you are buying funds from advises you on what schemes to invest in and why, then it is better to route your investments through him. The value of his advice may be more than the entry load and trailing commission.
