SIP with direct plan (low expense ratio) will accumulate lesser units!!!

POSTED BY Sumit ON February 22, 2013 4:31 pm COMMENTS (29)

Hi,

 

I have few thoughts regarding expense ratio, just want to clarify

 

1)     Firstly – expense ratio plays important role while choosing from a set of similar fund (more or less similar returns, category, risk profile etc.), or selecting same fund’s direct and indirect plan (which is 0.5 to 0.6% less for direct with AMC).

 

2)     Secondly – It seems to me that even for same fund’s direct and indirect plan the 0.5 -0.6% less expense ratio will not provide much benefit to investors, the reason below:-

I have seen in many discussion forums – people just calculate the % difference in expense ratio and then compare for a long time period (say 10, 15 years) and for a given SIP amounts.

 

But, what they simply forget that as NAV comes low for indirect plan (due to high e.r.), so in SIP approach we actually buy more units than direct plan (where NAV is high due to low e.r.).

Hence for same amount of SIP (say 5000 monthly), every month we are actually buying more units in indirect plan rather than direct plans, and at the end of tenure the unit accumulation should be much higher and differences in return would be negligible (or nothing?).

Hope, I am clear about my points, and let me know if I am missing some crucial calculations here due to my ignorance.  

What say financial advisors?

29 replies on this article “SIP with direct plan (low expense ratio) will accumulate lesser units!!!”

  1. Jig says:

    My understanding is:
    As the time pass,
    Indirect plan : rate of increase of UNITs is slow due to higher expense ratio compare to the
    Direct plan where rate of increase in NAV due to lower expense ratio.

    Am i correctly pointed out?

    1. You are kind of right. Since direct plans should offer more returns the rate of increase in NAV should always be higher than the rate of increase in units

  2. Sumit says:

    So, as I cannot see any mathematical conclusion to prove that direct plan will produce better return than indirect plan at any situations.
    I understand the logic of others that direct plans will perform better, and pre ER performance is same for both the funds, and hence you are saying it will generate better return to the investor.
    Yes, the pre ER performance is same for both the funds and hence Investors are getting high value for their NAV (and so buying less units in next monthโ€™s SIP). But return depends on both NAV and unit.
    Yes,so it seems that the direct plan will return more than indirect plan (due to underlying commission etc), but question is HOW MUCH??
    In different forum renowned financial advisers just taking the difference in expense ratio and calculating the return for a given period, CAGR and, invested amount. But it will not work like that in SIP (where you also have to consider the units difference purchased every month).
    Obviously difference is ER works very well for a LUMP SUM investment (where units are purchased once and then itโ€™s all about growing NAV).

    1. Sumit,

      The CAGR difference can be computed

      First Use
      http://freefincal.wordpress.com/direct-mf-plan-vs-regular-mf-plan-comaparator/

      to get the corpuses from direct and indirect funds with a trail commission of 0.6% (this is close to HDFC top 200 and equity)

      The use the “Mutual Fund SIP return calculator” in the main menu (second row in the middle)
      to calculate CAGR in both cases

      The difference in cagr will compound with time and I remember reading in VR that it will be close to 5% in about 5 years or so.

      One thing is clear assuming direct plans outperform

      the increase in NAV difference with time MUST be higher than the increase in units difference.
      I am curious to know the reason why. Let me ask around.

  3. Dear FFC, I’m still supporting my original view. To get a documentary evidence I’m asking to wait for 1Y to get DATA to support. Till this point of time, we are merely calculating based upon our calculation skills but I want to discuss the things, once there is actual performance difference. ๐Ÿ™‚

    Thanks

    Ashal

  4. Dear FFC, to understand this thing, one should wait till 1Y to see the impact.

    Thanks

    Ashal

    1. This
      “to understand this thing, one should wait till 1Y to see the impact.”
      implies that we have to wait to see if direct plans perform better. Which would contradict what you wrote earlier.

      They are all linked.

  5. Dear Raj, there are too many books & articles already. What is written already is not important, the important thing how much WE understand it & implement the same for our own good. ๐Ÿ™‚

    Thanks

    Ashal

  6. Dear Sunil, just answer a simple question. The portfolio of HT 200 Regular & Direct is same. If Expense ratio is leave aside for a while (consider zero ER in both funds), what ‘ll be return in both case? The answer is – return ‘ll be same.

    Now after earning the same return, Direct fund is applying 1.19% ER & Regular fund is applying 1.79% ER. Now show me the money. Where ‘ll be end result higher?

    Am I clear?

    Thanks

    Ashal

    1. Raj says:

      Ashal,

      You should write a book something named Mutual Fund for Dummies.

      I always tend to blame LIC for corrupting Indians investment mentality – I think it if anyone has to be blamed that should be the investor himself – after so many discussions and iterations by many financial bloggers that NAV & Units are just a numbers still people thinking of buying low NAV schemes and accumulating more units.

      1. Please don’t jump to conclusions on what others have understood. I think Sumit understands the argument about expense ratio and better returns. What he wants is that explanation translated into NAV and units
        In other words:
        The central point of the question is:

        Can you prove that this will always be the case and if yes why:

        โ€œThe lower no. of Units in direct plan โ€˜ll still outperform the higher no. of units of indirect plan due to difference of NAV on the maturity date.โ€

        NAV and unit on their own have little meaning. Their product obviously has meaning. The question is to extend the better returns explanation to this this product.

        That has not been done in this thread.

        1. Dear FFC, if we compare within Regular & Direct option of same fund, the result ‘ll be in favor of Direct plan. Why? The underlying portfolio is same. I.e. money is invested in same set of stocks & in same proportions. So pre ER performance ‘ll be same. Now after applying the ER, low ER ‘ll generate better return to the investor.

          Thanks

          Ashal

          1. Ashal, I understand that (would not have a made a calculator on that otherwise). The point is this implies that the increase in NAV difference with time will always be higher than the increase in units difference. The question is how does one explain that.

  7. You will get higher NAV for selling also..as similar to buying.

  8. LOWER NAV * HIGHER UNITs < HIGHER NAV * LOWER UNITs

    is possible if the % difference in NAV* is greater than % difference in units
    For the example given by Karthik

    * [(NAV(reg)-NAV(dir)]/NAV(reg)

    The % difference in NAV is twice as much as % difference in units hence
    value(reg) < value(dir).

  9. Sumit says:

    OMG!!! Are we making things too complex? This should be simple.

    Anyone understood what I am saying here, other than FFC and Sunil? Can I expect reply from Manish on this?

    Will see next week.

    1. Sumit,

      Karthik has said the same thing that you and I have

      9368.873514 (reg) < 9372.809688 (dir)

      OR

      219.924 X 42.60050524 < 220.112 X 42.58200229

      So for 1 month

      LOWER NAV * HIGHER UNITs < HIGHER NAV * LOWER UNITs

      Question is will this be true over say 15 years. Is yes why?
      That is your question.

  10. Sumit says:

    No Ramesh,

    You are getting my point wrong here. You said —
    “By your argument, you would incline to choose the MF with 20% expense charge. Since that will give you the most units. Is that Right or Wrong?” — WRONG

    I will NOT choose the MF with 20% expense charge since that will give you the most units —

    At the end the value of my money matters and hence
    Value(direct MF) = HIGHER NAV * LOWER UNITs
    Value(Indirect MF) = LOWER NAV * HIGHER UNITs

    So, at the end of the tenure, anything is possible as FFC correctly said — equal, more or less.

    Value(direct MF)> Value(Indirect MF)
    Value(direct MF)< Value(Indirect MF)
    Value(direct MF) = Value(Indirect MF)

    But may be we are missing some basics of trail commission deductions, which shall play important role here.

    1. Ramesh says:

      In the above spectrum, mathematically speaking- MF with 0% expense will be best, followed by 1.2% (Direct), then 1.8% (indirect) and the 20% expense Ratio MF is worst. This is what I want to say.

      The sequence will always be the same. In the above 4 options, either the zero expense ratio is best or worst. It is a linear equation and not a parabolic curve.
      End of my arguments in this.

    2. Karthik says:

      Don’t think too much.
      From our investment, Direct plan takes less expenses per year. So obviously we get more returns.

      Please see the below calculation from Actual NAVs of HDFC Top 200 fund :

      Person A bought Regular plan on 21-Jan-2013:
      Nav : 234.739
      Units: 42.60050524

      Person B bought Direct plan on 21-Jan-2013:
      Nav : 234.841
      Units: 42.58200229

      Value of their investments on 21-Feb-2013:

      Person A:
      42.60050524 units
      Nav: 219.924
      value: 9368.873515

      Person B:
      42.58200229 units
      Nav: 220.112
      value: 9372.809688

      Now choose whether you want more units? or more returns?
      (Though the above case shows a negative return, see the difference in the value of holdings)

  11. Ramesh says:

    @ Sumit and Pattu

    The NAV and units are just numbers. The only important thing to remember is the total return (which is what I said).
    So, even if NAV is higher, and number of units are lesser, you will ALWAYS get more return by decreasing the costs/expenses. This is simple common sense.

    My argument is simple: Will you choose a MF with option of zero expense charge, the same MF with 2% expense charge or the same MF with 20% expense charge? The portfolio and future returns are all same.
    By your argument, you would incline to choose the MF with 20% expense charge. Since that will give you the most units. Is that Right or Wrong?

    If you want to prove it mathematically, please do so using your excel powers. I do not have it.

    Hope I am clear.

    1. Nav and units are numbers which influence the CAGR (also a number). The nav listed is after deducting expense ratio

      Before we get too sidetracked by high-nav low-nav and high and low expense ratio, the central point is

      Can someone argue or prove this is always true (to borrow from Sumit)

      HIGHER NAV * LOWER UNITs > LOWER NAV * HIGHER UNITs

      Either mathematical or logical arguments based on how trail commissions are deducted alone will hold water

  12. Sumit says:

    @Ramesh — I didn’t understand what you mean?

    @FFC — you said correctly that mathematically anything is possible: equal, more or less returns. So , till now I really didn’t get the answer what I am missing here.You pointed correctly that it may be how trail commission deductions.

    @Ashal Jauhari — regarding your question of 400 Rs and 40 Rs NAV — I really would not mind choosing Rs 40 – NAV if 400 Rs NAV has only 100 units and 40 Rs NAV has 1001 units, in fact that would give me 0.1% more than higher NAVs. :). And I hope everyone (provided good in mathematics) thinks same.

    The number of units is merely an example too (based on Ashalโ€™s example). ๐Ÿ™‚ Never mind

    Thanks
    Sumit Nandy

  13. Dear Sunil, if you ‘ll get lower units, the price increase i.e. higher NAV ‘ll already take care off that thing you are pointing to. The lower no. of Units in direct plan ‘ll still outperform the higher no. of units of indirect plan due to difference of NAV on the maturity date.

    Your understanding is some what similar to what people think classically – High NAV means a fund is costly & low NAV means a fund is cheap, so opt for cheaper fund.

    Now I want to know, which one is good for your financial health? A 400 Rs. NAV fund or a 40 Rs. NAV fund if start date of both these funds is same? I’m giving merely an example & not quoting any actual fund just to know your views. ๐Ÿ™‚

    Thanks

    Ashal

    1. The central point of the question is:

      Can you prove that this will always be the case and if yes why:

      “The lower no. of Units in direct plan โ€˜ll still outperform the higher no. of units of indirect plan due to difference of NAV on the maturity date.”

      Because since the NAV and units have to multiplied to get the value, the increase in one can in principle be offset by the decrease in another.

  14. Terrific question! This is my incomplete (perhaps incorrect?) understanding:

    What matters is the value of the investment = (final)NAV X no of units.
    (from which CAGR is computed)
    If we say a direct plan has given more returns than the indirect plan then

    Value(direct MF) > Value(Regular MF)

    So the product of NAV(direct) X units(direct) should be greater than NAV(regular) X units(regular)

    If the increase in NAV offsets the decrease in units there will be no difference!
    So mathematically anything is possible: equal, more or less returns.

    Something is missing in this as Sumit points out. Would love to know what.

    Perhaps it is related to how trail commission deductions (or lack of it) affect the NAV each quarter.

  15. sunil says:

    This is something new that i heard….

    If that is the case then there is no difference between the money made from Direct and normal Mutual Funds Schemes.

    1. Ramesh says:

      @ Sunil

      Do not be crazy. ๐Ÿ˜‰

  16. Ramesh says:

    What about the total investment return?
    Calculate that.

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