Huge amounts of commissions are paid out to brokers, agents, and distributors when you invest. Most investors are unaware of the amount, the commission percentage, or the payout type. Because the systems were not very transparent in the past, these agents and brokers were able to secure large commissions.
Thankfully, SEBI and AMFI are stepping up efforts to enhance transparency and ethics. This is nudging all mutual fund AMCs and brokers to reduce their commission rates and offer better rates to end customers. Let us discuss the various product types and their commission rates today.
Mutual Funds
This is the best asset class to base your investment foundation on. MFs have coverage on equity, debt, gold, real estate, commodities, and international equities. Buying mutual funds is preferable to investing in these asset classes separately, as a responsible fund manager will handle diversification.
There are three ways to buy a mutual fund
- Regular mutual funds (Pay a commission to the distributor)
- Direct mutual funds (commission-free product)
- Advisor recommended Direct mutual funds (commission-free, but has advisory fees)
Regular mutual funds were the only product available in the market till 2013. You need to go via a distributor to make the purchase. The distributors are paid a trail commission on the total assets they manage. For example, if their trail commission is 1.5% and they manage 1 crore of your assets, the commissions paid out are 1.5 lakh per annum. This type of MF serves an important purpose in the market – Education. Typically, end investors are not aware of market developments or which MFs to buy. This is where a distributor helps them, and in exchange, the distributor receives a commission.
Direct mutual funds are easy to understand if you learned what a regular mutual fund is. If you deduct the paid-out commissions and add them back to your investment, it’s a direct mutual fund. Since direct MFs have no agents or distributors, they do not need to pay commissions. The AMCs can reinvest this amount back into the fund. Over the long term, a direct MF will outperform the regular MF. For example, LargeCap-Regular has a performance of 12% and LargeCap-Direct 13.5%. If InvestorA invests 10 lakh in LargeCap-Regular and InvestorB invests the same 10 lakhs in LargeCap-Direct, after 30 years, InvestorA will have a final portfolio of 3 crores, whereas InvestorB will have a portfolio of 4.47 crores. The difference is a staggering 1.47 crores.
Advisor recommended Direct mutual funds are a commission-free product as well, but it has an annual fee for the professional services provided by the investment advisor. If the advisor fees are 0.5%, then an investor buying a direct fund will save 1% every year compared to a distributor-led regular mutual fund. This translates into savings of approx 1 lakh per annum.
If you ask me, the best option is to start with regular mutual funds. If you start investing in direct mutual funds without guidance, you lose out on expertise and effort. By the time you realize, the damage will have already been done. If your investments are sizeable, say above 10 lakhs, then the best option is to opt for an advisor-led direct mutual fund, because you can start seeing the commission savings pretty easily. In case you already have an economics or finance background, you can start buying direct mutual funds without consulting an expert.
I provide the third option to the investors. Being a SEBI registered investment adviser, I charge a flat upfront fee from the investor. Before charging any fees, I provide a written schedule of the charges. This helps in transparency. Work begins only when the client provides the go-ahead.
Stocks
Once the foundation is established through mutual funds, I encourage investors to consider investing directly in equities. Investing in stocks can create significant wealth over the long term. The reason is obvious: a company’s share price can go to infinity, but its maximum decline is zero. If you get the stock right, you can create generational wealth; if you get it wrong, the maximum you can lose is the amount invested.
My approach is to identify a basket of 5 high-quality stocks and allocate your initial capital across them. The advantage is downside protection: the maximum you could lose is only 20% of your capital, rather than 100% (assuming only 1 of the stock goes to zero).
Finding 5 stocks that suit your risk profile comes with a fee. It will be Rs 1199 per stock unit, payable upfront. If you opt for the fund management package, I will monitor the performance of these stocks and recommend a replacement if either share falls below a pre-set threshold. The cost of replacement stock is free.
Investing is done through brokers that do not charge transaction commissions. This ensures the pricing you get is fair and transparent. The new generation of brokers, such as Zerodha, Groww, and Dhan, does not charge brokerage on buy/sell transactions in the equity category. This is to reassure you that I do not receive commissions or incentives from the broker; my earnings are from a fee charged to you under our contract.