Sneha Chopra is a savvy investor. She follows the principles of asset allocation religiously, setting aside money for equity, debt, gold and real estate based on her life goals. Because of her hectic schedule, she depends heavily on her trusted agent to make her investments. Her dependence on the agent in no way means that she is unaware of the returns, the performance of her funds or what the agent is earning.
The smart investor in her got a shock recently when she saw one of her colleagues investing online. Under the plan he was investing in, he was not paying commission. The money thus saved was added to his returns. Over a period of time, it added up to make a big difference in earnings.
Chopra scrutinised Birla Sunlife Advantage Fund, a scheme that she had invested in. The year-to-date return of this fund in direct plan (that is, when you invest online) was 3.93 per cent, while the return for the same scheme when invested through an advisor (regular plan) was 3.5 per cent. This was because the expense ratio for direct plan was 1.49 per cent, compared with 2.38 per cent for regular plan.
Being someone who loved doing things online, Chopra wondered why she had not opted for direct plans. Obviously, her advisor could not have told her that they existed.
Direct plans came into being in 2013, when the Securities and Exchange Board of India asked mutual funds to create a separate plan for investors coming without a distribution channel. While investing in direct plans, investors deal with the asset management company directly, either through offline or online channels, and no intermediary is involved.
“Direct plans have a lower expense ratio since they do not engage distributors, thereby saving on distribution expenses and commissions paid to the distributors. Because of the reduced costs, the returns from these funds increase by a similar extent,” says Anil Chopra, chief executive officer of Bajaj Capital.
Expense ratio is the expenses charged by a fund house towards distribution, fund management and other costs incurred by the fund. The maximum expenses, or total expense ratio (TER), that can be charged by a fund house is capped at 2.5 per cent for equity funds and 2.25 per cent for debt funds. The higher the expense ratio, the lower the return.
Say you invested 010 lakh in a fund with a TER of 2.5 per cent. If the fund earns 15 per cent and its TER is 2.5 per cent, it would mean a net return of 13.5 per cent. In this case, Rs 10 lakh invested for 10 years at 13.5 per cent compound annual growth rate would grow to Rs 32.50 lakh. A 1 per cent lower charge would mean this amount would grow by 14.5 per cent to Rs 35.5 lakh.
“For investors who are wise enough and well aware of the investment scenario, it makes sense to take the direct plan route because one can earn that much extra. But, if you are not clued in to investments, do not go directly just to save a little bit on expense charges. Choosing a wrong fund might prove to be costlier,” says Hemant Rustagi, chief executive officer of Wiseinvest Advisors, a personal finance advisory firm.
Another financial product where commissions make a huge dent on investments is insurance. In mutual funds, the total expenses are capped and distributors earn a trail commission every year, reducing the incentive for a distributor to keep churning his client’s portfolio.
In insurance, however, distributors are paid a significant amount as upfront fees. “In traditional plans, commissions go as high as 35 per cent in the first year itself. ULIPs (unit-linked insurance plans), too, have a commission structure tilted in favour of distributors,” says Chopra.
As a result, the insurance industry continues to see high lapsation and low persistency of policies. According to the Insurance Regulatory and Development Authority (IRDA), on an average less than 60 per cent of policies get renewed after a year of buying the policy. In fact, at the end of the fifth year, the industry on an average was unable to retain even a third of its customers.
This is because a major part of distributor’s income comes in the first three years, the interest to renew policies beyond that becomes much less. While the IRDA has come out with a draft paper on commission and remuneration of insurance distributors, there is a lot that is missing. First and foremost among them is the alignment of investor and distributor interests.
To save your hard-earned money from being spent on insurance commission, personal finance expert Balwant Jain advises not to load up on too much insurance. “In India, we have a habit of buying much more insurance than we need,” he says. “A pure term plan solves most of the insurance needs for people. ULIPs are the most confusing product. It is much better to invest in a mutual fund than a ULIP, which is neither an investment nor an insurance.”
A low-cost and well-managed product among a plethora of investment options is the National Pension Scheme. There are minimal charges for record-keeping, custodial expense, fund management and point of presence. The record-keeping agency charges Rs 190 annually for maintenance of the account. Custodial and fund management charges are miniscule.
“NPS has been acknowledged as one of the best retirement products,” says Chopra. “Its low cost structure makes it all the more attractive. In fact, it is much better than investing in an insurance company’s pension plan.”
Most of the government’s small saving schemes do not have any commission structure. In 2001, the government discontinued commissions for Public Provident Fund, Senior Citizen Scheme, Monthly Income Scheme, National Saving Certificate and Kisan Vikas Patra.