Investing in Mutual Funds is not rocket science! It is rather easily done!

Investing in Mutual Funds is not rocket science! It is rather easily done! If you are planning to invest in mutual funds, there are two ways to go about it: either you can go through a distributor or advisor, or you can directly approach the mutual fund companies. For either way you choose, you must be aware of the costs involved and other fine print.

Investing through a distributor or advisor? You should know this
A distributor or advisor will provide you assistance with selecting a fund and with actually making the investment. For this service, they earn a commission or a fee. The primary difference between an advisor and a distributor is how they earn their fee – directly from you or indirectly.
An advisor charges you an Advisory Fee that is mutually negotiated and in agreement between you and the advisor. The fee may be related to the investments you make or it can be fixed fees for the financial planning and any other advice that the advisor provide.

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A distributor, on the other hand, earns a commission ranging between 0.5% to 1% from the mutual fund company. This will be indirectly paid by you as part of the expense ratio. Recognising that this amount is usually very small, SEBI also permits the distributor to charge a transaction charge of Rs 100 to the customer.

Before 2014, an advisor could charge you a fee as well as get paid a commission by the mutual fund company. This practice has been banned by SEBI and every entity that collects mutual fund investments must choose between offering advice or be a distributor and get paid only once.

If investing directly with the mutual fund house, then be aware…
All mutual fund companies provide a way for you to invest directly by approaching their office or online. This had no advantage for an investor until the introduction of the Direct Plan.
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Now investors can approach a mutual fund company directly and invest in the “Direct Plan”. You can do this in 2 ways.
(i) Visit the office of the AMC or their appointed RTA (CAMS, Karvy, etc.) and submit a form along with your PAN Card copy and cheque.
(ii) Sign up online with each of the AMCs that you wish to invest in and invest online using their payment gateway.

How do these two options compare?
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Currently, Direct Plans of equity mutual funds have expense ratios that are typically 0.4-0.5% lower. This means that your return by opting for the Direct Plan is higher by that amount. What does this mean in actual money? For example: If you invested Rs 100 for 10 years in equity mutual funds, you could expect to have Rs 370 in a direct plan vs. Rs 354 in a regular plan. This assumes a 14% annualised return for Direct plan and a lower 13.5% return for the Regular plan. The addition of Rs 16 over 10 years is what you make by taking the direct option.

Why would you want to invest in a regular plan through a distributor or advisor?
This is a matter of great debate while distributors bring in the experience that you lack, chances are that you may take better decisions yourself by learning about mutual funds and spending the requisite time and effort. The catch however is, to achieve better results you must follow a disciplined process of investing.

But if you opt for distributors and advisors, then this is what all they would:
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· Determine which investment options are right for you
· Analyse and understand these investment options
· Select specific funds to put your money into without any commission induced bias
· Facilitate the investment or withdrawal
· Track and monitor your investment
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· Recommend changes as and when required
· Help you take the right exit decisions after considering tax and other costs
· Help you follow a disciplined investing process

So, in a way, you are paying your distributor or advisor an indirect fee for the service they provide. This is similar to the fee you pay your doctor, lawyer or other professional for providing their services in an area you may not be most competent in.
If you still can’t decide whether to invest directly or through a distributor/advisor, answers to the below-mentioned questions would help you take a decision:
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  • Is your distributor providing valuable services for the fees you pay them? Use the checklist above and ask them the question.
  • Whether you need the extra help from them? Their advice and guidance may be more valuable than the 0.5% saving. This could come in the form of extra return earned on better recommendation or saved costs. Also, your own time may simply be worth much more than what you pay them.
The Next Lesson on this series will be: What Is KYC And Why Do I Need It. If you would like to learn more, stay tuned.

(About the author: This article has been contributed by Sanjiv Singhal, CEO, scripbox.com.)