#PaisaVaisa Podcast 1: Why do Direct Plans of Mutual Funds mean more money for you?

In a first of a series of three podcasts, Kunal Bajaj, Founder & CEO of Clearfunds, joins popular #PaisaVaisa podcast host and blogger, Anupam Gupta, to talk about mutual funds and personal finance.

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Anupam Gupta: Kunal and I are ex-colleagues from a fairly large brokerage firm where we spent the better part of our days trying to convince people to buy stocks in India. It’s great to have you here Kunal. Good to see you after a long time.

Kunal Bajaj: Thanks Anupam, pleasure to be here.

Anupam: I want to get into the entire debate of this of direct investment in a mutual fund versus investment done through an advisor. Over the last few years, we’ve had this huge discussion about the fees that are charged to investors like me who want to invest in a mutual fund. A decade ago, in 2007–8, the entry load or the expense loads used to be 2.5% and obviously it was misused. People would say that invest 1 lakh rupees in a mutual fund and the distributer would give the investor a nice cash back. I think at some point of time, SEBI cracked down on that and over the last 10 years regulations have come into play and now the debate is “Should a retail investor go through a direct route or through an advisor/distributor?”

Kunal: I think, to put it in one word — what SEBI is trying to achieve is transparency. SEBI is not saying whether you should pay a distributor or an advisor or a bank. They’re not trying to judge that, they’re just trying to advocate for transparency. And the problem really is when you try to buy a regular mutual fund — most people don’t realize that there is an annual commission paid to somebody. When you buy a direct mutual fund — there is no commission paid to anyone and the advisor explicitly needs to ask the customer for a cheque for the services he’s providing. That’s basically what people are up in arms against. You know, when someone tells you that regular mutual fund is the way to go — what they’re saying is “We don’t think the customers will benefit from transparency of knowing how much we charge for the services.” And that to me is inherently wrong.

Anupam: Okay I’m going to break some terms down. So, when you say, “regular mutual fund” it’s like me, I wake up one fine day, it’s the first day of my job and I’m like “I want to invest in a mutual fund.” And I say “Arrey yaar chalo — isko phone kiya, family se pucha, haan-haan yeh hai apna — we know this guy…he does mutual funds.” You know, he distributes mutual funds so I go to him and say, “SIP chaalu kara do” and that guy sits with me, offers me all kinds of services, he will get my KYC in place and he will fill up forms and possibly, will even suggest which mutual funds to buy. That, is a regular mutual fund, am I right?

When you buy a Regular Mutual Fund — you’re not just paying commission for the first year of purchase, you’re paying annual rent as well to stay invested each year.

Kunal: Broadly, yes. But you have to realize who you are transacting with — what license he’s operating under, who is this person giving you advice. If this person giving you advice is a distributor, then he’s selling you regular mutual funds. If he’s a banker or a relationship manager, he’s selling you regular mutual funds. The only kind of people who sell you direct mutual funds, are investment advisors that have, what’s called a registered investment advisor license, and who explicitly tell you that “We have a separate fee for our services.”

The way I like to think about this is very simple — imagine if you were buying a house, someone takes you to buy a house, someone fills out the necessary forms, introduces you to the right kind of seller in the right area at the right price — of course that’s a service you should be paying for! But when you buy a house you pay for the service to a broker only once. When you make a purchase in regular mutual funds, you pay the guy once when you make the purchase and then pay him every single year until you take the money out. So, you’re not only paying the brokerage on a house you bought, but you’re effectively paying rent as well.

Anupam: So that’s like saying I’m paying him something like an “up-front” commission.

Kunal: Yes …

Anupam: And then I pay him trail.

Kunal: So, you don’t really pay him an upfront commission. Upfront commissions are banned, but you pay a trail every single year.

Anupam: Okay. And this is what is called regular?

Kunal: Yeah. So, what’s really surprising when people recommend regular mutual funds is that, they tell their customers or investors, “You’re in it for the long term. You’re investing for a long term, you’re starting an SIP for a long term, never stop your SIP!”

That advice is given only once. And yet the person giving the advice earns a trail for life.

Anupam: So, if I stay in an SIP for 10 years, and he just helps me on day one, he’s going to benefit for each of those 10 years from my investments.

Kunal: Absolutely. And not only on the original amount — not only on the Rs. 5,000 or Rs. 10,000 you invest every month, but whatever your investment grows to.

Anupam: Right. And that’s a fantastic point I’ve seen on your blog as well, that if you stay invested in a regular fund for 10 years on an SIP, how much of your money, or your profits goes to paying, the advisor.

A quarter of what you should be saving for your retirement, for your kids, of what you have worked hard for goes to your advisor — just for him to remind you to stay invested in the “long term”?

Kunal: It’s actually clear as daylight. Let’s take the case of a 35-year old investing for the next 30 years. I’m trying to make it as simple as possible because you start at the age of 35 and retire at age 65, you’re going to be invested in some mutual fund for the next 30 years, whether it’s A, B, C or D.

Anupam: And whichever way you take it, it could be in equity, it could be in debt, but it’s going to be there for 30 years.

Kunal: Yes. So, if a 35-year-old investor were to put 10 lakh rupees in a mutual fund, which earns him 8% a year for the next 30 years (I’ve taken 8% because it’s a reasonable number).

Anupam: I do, I do. And I think that the interest rate today is around 6.97% or 7%, so 8% is fine.

Kunal: So, if a 35-year-old investor were to put 10 lakhs away in a mutual fund or a bunch of mutual funds, earn 8% a year for the next 30 years, that 10 lakhs grows 10 times to 1 crore.

It’s the compound interest formula at work. A = P (1 + r/100) ^ n.

Anupam: Or just go into excel and just feed the number yourself and that’s the number that you’re going to get.

Kunal: Absolutely. Now that same investor, decides to go with a distributor and pays away 1% a year each year to the distributor. His return drops from 8% to 7%. And guess what? 10 lakhs compounded at 7% for the next 30 years grows only seven-and-half times to 76 lakhs.

Anupam: Wow. Instead of 10 lakhs to 1 crore.

Kunal: So, you’re giving away, a quarter of what you should be saving for your retirement, for your kids — a quarter of what you have worked hard for, away to your advisor. For what? To help you sign a couple of forms and tell you to stay invested in the “long term”?

Anupam: So that’s really the rub, isn’t it? You’ve got this really big chunk of money that goes towards paying a distributor, which, I don’t think investors are aware of this — I mean — what’s been your feel when you speak to people about this? Do you think do they even know this?

Kunal: The distributors and advisors have done a great job — you know — talking about SIPs and talking about the right way to invest, talking about compounding — and educating the masses. We have Rs 5000 crores a month now coming in these SIPs which is really encouraging, it tells you that the saving culture is really catching on.

Don’t forget — Investing costs also compound over time.

Kunal: Compound interest is magical, the 8th wonder of the world –

Anupam: Warren Buffet? Or whoever-

Kunal: I think it was Einstein, but let’s leave that for a second. Don’t let the magic and the miracle of compounding your returns, be overwhelmed by the tyranny of the long-term compounding of your costs.

Anupam: Costs also go up.

Kunal: Absolutely. Returns compound over time and just as your returns compound over time, your costs also compound over time. And that’s what investors need to realize.

Anupam: I’m just surprised at how this debate has come over the last 4–5 years which is especially the time when SIPs have gone up, the numbers were right. And from what I’ve heard, there are about 1.3 crore of SIPs of an average value of 4 or 4 ½ thousand now. So then wouldn’t that strengthen the distributor’s case and he would say this has happened because of me and my services and if I did not give this to the last mile, to the end consumer, then how would you get so much of fund flow into the mutual funds. Is it justified or is it not justified?

Kunal: Totally justified, to the extent that they have the customer’s trust. To the extent that the customer believes that they cannot do it themselves — without any hand holding whatsoever. I think a lot of investors are well served by distributors. But a lot of investors are doing it themselves, on bank platforms. They’re going to their banks, they’re clicking on the tab that says mutual funds. There are better ways of investing now. Earlier — 15 years ago — there was virtually no way to reach a customer who was sitting in Vishakhapatnam or Srinagar or Kochi, from an office in a larger city like Bangalore or Mumbai. You had to have an army of distributors — feet on the street.

But guess what? If people can buy things on Amazon and Flipkart from all over the country and it gets delivered the day, why can’t we deliver an investment product in seconds?

Anupam: Right. I can’t argue with that. I agree.


That was the first of our three-part series on mutual funds. Stay tuned for the next two!