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Is direct mutual fund investing platform a better way to invest?

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Tejas Khoday

What if a lawyer offers to fight a case on your behalf for free, would you take it? If the answer is no, why would you accept the same offer from a mutual fund advisory? The answer is not simple. To understand the basic difference between direct mutual funds and regular mutual funds, you will have to understand what happens behind your eyes. The vast majority of retail investors are completely unaware of how the distribution/brokerage model works. In this article, I will explain it to you in detail so that you can be the judge and decide which one is better for you.

How the mutual fund industry works: Asset management companies (AMCs)/ mutual fund companies have expensive setup and operating costs. Their business is only viable if done on a mass scale as they earn only a few basis points of the total expense ratio. Most asset management companies don’t have a distribution reach beyond their immediate circle of influence (Their business connections, friends, relatives, relatives of stakeholders, strategic alliances etc.). Also, it is not feasible to hire a very large sales team. Hence, they all rely on external sources to help get new investors’ money into their mutual funds and increase the assets under management. The external sources who help increase the total investor base and amount are known as distributors. These distributors (aka mutual fund advisors) are responsible to convince investors to invest in a particular mutual fund scheme. They don’t charge the investor any fees for their services because they are getting a commission from the fund houses directly. Essentially what happens is that the fund house charges an annual management fee which is <2.5% of the total investment amount on a yearly basis. Out of this, approximately 1 to 1.8% is given to the distributor as a commission on a yearly basis (paid monthly), for as long as the investors remain invested with the mutual fund. Any incremental investment into the same fund will also entail a commission to the distributor regardless of whether or not they helped you in any way. For example, if you invested Rs 5,00,000 in a mutual fund on the advice of someone who hasn’t charged you a fee, that person/agency will earn approximately between Rs 5000 to Rs 9000 from you on a yearly basis.

The icing on the cake for the distributor is that as your investment amount appreciates, the percentage based commission will be paid on the latest investment value and not on the initial amount of investment. For example, if your Rs 5,00,000 investment has gone up to say Rs 10,00,000, the distributors’ commission will now be between Rs 10,000 to Rs 18,000 per year in trail commissions. This effectively reduces the investors’ return to that extent. Because of this kind of incentive system, distributors will almost always choose to sell those funds which give the highest commissions since their income depends on it. From a broad perspective, it has been a win-win situation for everyone involved because the asset management companies managed to perform well and in many cases outperform the markets.

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Who are these distributors: There are various types. The largest distributors of regular mutual funds are the banks and the national/regional wealth management firms. They have a sizeable market share in this business as they have a vast reach through their extensive branch networks across the country. Their reach allows them to get new investors. Apart from that, the Independent Financial Advisors (IFAs) are individuals, small firms that advise people to invest in mutual funds. Although they are small in size, there are over 85,000 IFAs that employ over 1,70,000 people who are on selling mutual funds across India’s Tier 1 and 2 cities.

How things are changing: However, there is a sense of awakening now as the regulator realises that many distributors have been misselling funds and their income stream represents a conflict of interest because they are likely to act in favor of the fund houses rather than the investors because they get paid by them. To change the scenario, SEBI is trying to make the market more transparent by mandating additional disclosures to be made public on a half-yearly basis about how much the mutual fund distributor earns in absolute terms. There is now a mechanism that allows investors to directly invest in mutual funds at the click of a button, just like stocks. These platforms can offer direct/regular funds depending on their business model. Platforms which offer regular funds don’t charge the customers directly whereas those that offer direct funds charge a nominal platform fee.

Main differences between direct mutual funds vs regular mutual funds and platforms that offer them:

==Direct mutual funds have a lower expense ratio than regular funds because the fund house doesn’t need to pay the distributors any commissions.
==Direct mutual funds give higher returns because investors save about 1 to 1.8% per year as there is no intermediary.
==Direct mutual fund execution platforms have fixed fees per year regardless of the size of your investment. Although regular mutual fund platforms don’t charge, they earn much more indirectly.

==Direct mutual fund platforms charge separately for advice which can be discretionary whereas regular mutual funds don’t charge you anything for advice.

In general, people have a reluctance to pay a recurring fee for investment services which is why direct mutual funds are not very popular as yet. In the larger scheme of things, what really matters is the quality of advice being given and the net returns you make as a result of the advice. If you’re not looking for advice, then going direct makes the most sense. Make your investment decision after factoring in the above information.

(The writer is CEO and Co-Founder FYERS)

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Boost Your Investing Returns By Lowering Your Investment Costs

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Doctors can increase the health of their portfolio by monitoring investment costsGetty

Limiting your investment-related fees and expenses is a critical aspect of investing. In my work at The White Coat Investor helping doctors, attorneys and similar high income professionals develop financial literacy,  I have repeatedly seen that most investors are paying far too much in investing expenses. Reducing these is one of the most reliable ways to boost your return without taking on any additional risk. Unlike many things in life, in investing you get (to keep) what you don’t pay for.

Reducing investment expenses could potentially allow you to retire years earlier with far more money. Consider two investors, one of whom is paying 2% of the portfolio each year in investment related expenses and 1% of the portfolio in taxes (3% total) to an investor paying 0.1% in expenses and 0.4% in taxes (0.5% total). If we assume they both invest $50,000 per year for 30 years and earn 8% before fees, how much less will the investor with the high expenses retire with? A quick calculation shows that she will end up with 37% less ($5.6 million vs $3.5 million.) As the investor moves into her retirement years, those high expenses continue to limit the amount she can spend from the portfolio and make it far more likely that she will run out of money.

It is critical that an investor examine each of these five categories of expenses and minimize them wherever possible.

# 1 Advisory/Management Fees

Perhaps the largest category of expenses are those paid for financial advice and investment management services. Many in the industry consider 1% to be a standard level of fees. However, on a multi-million dollar portfolio, 1% can add up to $20,000, $50,000 or more each year for the exact same work the investor used to pay $5,000 for. When paying an advisor an Asset Under Management (AUM) fee, it is critical to do the math each year by multiplying the portfolio size by the fee.

Since there are many high quality advisors willing to provide these services for $1,000 to $10,000 per year, it seems silly to pay $50,000. A better arrangement (for the investor at least) is to pay either a flat annual fee for investment management and/or an hourly rate for financial planning. Although your fees will still likely add up to a four figure amount each year, at least they will not be a five figure amount.

Recognizing the importance of costs, some interested investors have decided to educate themselves about investing. With time, the necessary knowledge and discipline is relatively easy to obtain, but the potential do-it-yourself investor should be cautioned that they would be much better off paying a fair price for good advice than doing it poorly themselves. Of course, there are hybrid solutions that can reduce fees dramatically. These include enlisting the aid of a financial planner with the initial development and implementation of a plan and then maintaining it yourself. One could also meet with an hourly rate advisor periodically for a second opinion and a sounding board on any changes to their plan.

# 2 Mutual Fund Expense Ratios

Another significant fee for most investors are the expenses associated with running the mutual funds they invest in. Yet again the industry seems to believe that 1% is the industry standard. However, using low-cost index funds from providers such as Vanguard, Fidelity, iShares, and Charles Schwab you can relatively easily reduce that cost to less than 0.1% per year. Every dollar saved is a dollar that remains in your portfolio working for you.

Some beginning investors might wonder if paying cut-rate prices gives them cut-rate returns. However, time and time again it has been demonstrated that over the long run low-cost index funds outperform the vast majority of their actively-managed peers. In fact, having low costs is one of the best predictors of future returns of mutual funds. It certainly works better than looking at past returns, the method most investors use. It isn’t that the managers are stupid. On the contrary, the issue is that they are all so smart that they make the market efficient enough that the game of trying to beat it is no longer worth playing. They can add value, but not enough to overcome the cost of playing, especially once taxes are taken into consideration.

# 3 Commissions

Investing-related commissions are an interesting expense to consider. These can be completely eliminated by a do-it-yourself mutual fund investor who buys funds directly from the fund provider. However, many investors are paying huge amounts in commissions. This is often a result of mistaking a commissioned salesman for a fiduciary, fee-only financial advisor. While they think they are being given unbiased investing advice, they are actually being sold high-expense mutual funds and insurance products such as annuities and whole life insurance by a broker operating under the suitability standard rather than the fiduciary standard. At times these salesmen may obscure the fact that they are charging commissions by calling them “loads” or even telling the investor that the insurance company is paying that cost, not you. Of course, all expenses are ultimately paid by the investor.

Even a do-it-yourself investor may be running up the commission bill. A commission may be charged each time an individual stock or ETF is bought or sold, even inside a qualified retirement plan like a 401(k). Even at a rock-bottom price of five dollars per transaction, if you’re doing 20 transactions a month it adds up to $1,200 per year. While you don’t necessarily want the expense tail to wag the investment dog, every little bit helps keep costs down and returns up.

# 4 Turnover-Related Costs

Wise mutual fund investors always look at the turnover percentage when selecting a fund. Embedded in that percentage are some hidden expenses paid by the fund but may not be included in the expense ratio. Costs include commissions paid by the fund and bid-ask spreads that allow the market-maker to cover her own expenses and profits. A broadly-diversified index fund may have a percentage less than 10% (meaning less than 10% of the stocks in the fund are bought or sold each year) while an actively managed mutual fund may see a turnover percentage of 200% or more. A long-term, buy-and-hold investing philosophy on the part of the fund and the investor helps keep these costs down. A speculating day-trader is continually whittling down the nest egg with each transaction.

# 5 Taxes

Taxes are another major expense borne by the investor. Although this expense helps pay for government rather than the financial services industry, it lowers the investor’s return all the same. There are many techniques for lowering these costs, and a good advisor or do-it-yourself investor should be familiar with most of them. Investing in tax-advantaged accounts such as 401(k)s, Roth IRAs, Health Savings Accounts, and 529 College Savings Accounts makes a big difference. So does limiting turnover by lowering capital gains taxes due, particularly short term capital gains taxes. More advanced techniques include tax loss harvesting, tax gain harvesting, using appreciated shares for charitable donations, use of municipal bonds when bonds are held in a non-qualified account, and appropriate tax location of asset classes.

Lowering your investment related expenses are a sure-fire way to boost your returns, hasten your retirement and allow for a more comfortable retirement without taking on additional risk. Do all you can to reduce your advisory fees, mutual fund expenses, commissions, turnover-related costs and taxes.

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How millennials are changing the way the we invest

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By Jean Chatzky

When you think about making an impact with your money, what comes to mind?

There are always philanthropic efforts you can support, but what about investing your money in a way that makes a social or environmental impact, while also making you a profit? Often called “ESG investing” (environmental, social and governance), “SRI” (socially responsible investing), “CSR investing” (corporate social responsibility) or simply “impact investing,” the concept has been around for years, but millennials are charting new territory when it comes to doing good with their money.

Today, 43 percent of millennials are more likely to consider making impact investments versus only a third of Generation Xers and a quarter of Boomers. When those surveyed were asked what’s more important — making money or making an impact — the majority of all investors (67 percent) said they would prioritize having an impact. “They aren’t saying, ‘I’m willing to lose money,’ but they are saying, ‘Even if I have to get a slightly lower return, I’m okay with that to improve social issues and company governance,’” says Lule Demmissie, managing director of investment at TD Ameritrade.

The Global Impact Investing Network reported that nearly $140 billion was invested in impact investment strategies, up from just $10.6 billion in 2014 — a staggering increase.

Except that, they often don’t. Impact investments have outperformed the benchmark for eight out of the last 10 years, according to the MSCI ESG Leaders Index. During the same period, impact investments also showed they were better protected from the downside in the market. That’s why even people who aren’t so passionate about saving the world may want to get on the bandwagon (and why the bandwagon is turning into quite the parade.) In May, the Global Impact Investing Network reported that nearly $140 billion was invested in impact investment strategies, up from just $10.6 billion in 2014 — a staggering increase. Additionally, impact investment network Toniic reports that its members now have $2.8 billion total in impact investments, up more than $1 billion since 2016.

“As the industry continues to grow and mature, we believe that over time, there will be no ‘impact’ investing — it will simply be investing,” says Michael Tiedemann, CEO/CIO of Tiedemann Advisors.

Human Rights Is Leading The Way

So, where are people putting their money? Human rights was the most popular cause category for investors, followed by the environment and diversity, according to the survey. Millennials favored environmental impact and human rights, women tended to opt for gender equality, while men leaned toward diversity. Nearly half of millennials — 47 percent — felt so strongly about impact investing they said they would move their brokerage account to gain broader access to socially responsible investments.

Of course these conscious choices aren’t just impacting portfolios — publicly traded companies are starting to realize that it’s good for their business to give a more critical look at which suppliers they’re using, or how much of an environmental impact their operations may make. “In some cases, companies are changing their behavior, and you can give investors the credit for the rapid momentum of those changes,” Demmissie says.

July 20, 201701:05

A Contributing Factor in the Disappearance of Straws

Companies seeking to ensure long-term success may need to take a hard look at some of their policies, says Jordan Farris, Head of ETF Product Development at investment services firm Nuveen. “Starbucks is a good example of a company adjusting its business model,” he says. “As concern regarding the increase in ocean plastic has grown, Starbucks has made the decision to eliminate single-use plastic straws by 2020.”

For investors looking to ensure their money supports the “best” companies, Farris cautions that the definition of what makes a company responsible can vary widely. Overall, it’s any company that is incorporating “positive environmental, social and governance practices into its core business model,” he says. But investors can also have an impact simply by choosing not to invest in companies that are involved in major controversies, that pollute, or that manufacture tobacco or firearms, etc.

How Do You Do Well By Doing Good?

Investors looking to do their due diligence on a company before they invest need look no further than the internet, explains Nick Kovacevich, CEO of KushCo Holdings, the parent company of several cannabis industry firms. “Information is so ever-present today, and it’s not difficult for someone to do 30 minutes of research on a company and come to a determination if they are socially and environmentally conscious.”

If millennials have proven nothing else over the last decade, it’s that they’re willing to push boundaries, even when — perhaps especially when — it means a break with convention, and that’s exactly what we’re seeing with impact investing, Tiedemann explains. “They’re questioning the traditional view of making investments to create wealth, and then once they’ve made money, donating it to their charity of choice.” They’ve decided they want to get the double investment benefit of a social and a financial return, and they’re demanding that the marketplace provide it.

And while it may be the millennials leading this charge now, they’re really just the thin end of the wedge, Kovacevich says. “Millennials are going to teach their children the same ethics and values that they have,” he says, and the impact investment train is only going to build momentum as it chugs along. Tomorrow’s companies will either choose to hop aboard, or find themselves left at the station.

With Kathryn Tuggle

HOW TO SAVE MORE MONEY

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Investing in Education, Self Storage in China

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  1. Investing in Education, Self Storage in China  Bloomberg
  2. Full coverage



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