In Part 1, we talked about what an MFD is and whether you should work with one. A licensed Mutual Fund Distributor is required to pass the SEBI-mandated NISM-Series VA exam and received an ARN number (Association of Mutual Funds in India Registration Number). You can enter a person’s name/ARN at this official link to check if they have an active license – AMFI website. (My ARN is 297451; Rohan Ashok).
What it takes to build a portfolio yourself
While you could directly buy mutual funds through apps like Coin/Groww/CAMS etc., some people may prefer to outsource this job entirely. If you plan to build and manage your own mutual portfolio, ensure you have the following:
- Knowledge of the categories of mutual funds
- Knowledge of the different risk profiles of each category and how to match categories to different goals/time horizons/risk appetites.
- The ability and knowledge to build a balanced portfolio, based on good asset allocation, risk management, and suited to your specific needs.
- The ability to rebalance the portfolio in the face of changing needs and market fluctuation.
- The confidence and ability to behave appropriately in the face of market volatility.
If you decide the above is not for you, then working with a licensed MFD could be a very sensible way to obtain good average returns from mutual funds with minimal work, stress, and time. A mutual fund distributor’s job is to understand his/her investor, their goals, risk profile, and their unique personal financial profile. Personal finance is more “personal” than it is “financial” many times.
What does an MFD do?
Once this groundwork is set, the MFD can then assemble a balanced and powerful portfolio that serves the investor’s needs. This is where his/her technical knowledge comes into play. Selecting funds, ensuring the asset allocation is appropriate, and building a portfolio that can deliver good risk-adjusted returns relative to the investor’s needs. The MFD will track the portfolio over time, have periodic calls/meetings with the investor to update them on the performance and provide ongoing support and continued advice. The most crucial part of an MFDs job is to counsel investors during times of market turbulence and ensure that investors avoid bad decisions driven by emotions.
How do MFDs earn an income?
MFDs must be compensated in return for these services. SEBI rules clearly state that MFDs cannot receive payment from the investor directly, either through a fee or any other out of pocket cost. Mutual fund companies pay MFDs a commission on the market value of the investment by the investor. MFDs ensure that the funds suggested are in the investor’s best interests, and the funds pay a commission on the back end. The commissions paid to MFDs technically reduce the overall gains to the investors. The investment values investors see are after all such commissions.
The fund suggested by an MFD are called “Regular” funds. They carry a higher expense ratio (what funds charge investors to managed their money) compared with their “Direct” version. This extra expense ratio/commission could be worth it if you think the portolio designed by the professional MFD could deliver better returns than a portfolio you design.
Why working with an MFD could give you better returns despite added expense ratios
For example, you create a portfolio of “Direct” funds that carry a low expense ratio. If you lack the fundamental knowledge mentioned earlier, the portfolio may not be a balanced/good one and over time you could average (lets say) 10% p.a. If you work with an MFD, you will be investing in “Regular funds” and pay (for example) 0.8% extra every year. However, the portfolio that the professional designs could be more balanced and technically sound, and deliver 13% p.a. compared to the one you design yourself. In such a scenario, you pay 0.8% extra per year (back-end, not out of pocket) and receive 3% extra gains. Compounded over time, this 2.2% extra p.a can translate into a significant sum. For example, a 20,000 rupee monthly SIP over 15 years could earn you ~18 lakh rupees more with an extra 2.2%. This is not even considering other benefits, like having a professional to counsel you during times of market volatility, avoiding emotional decisions that could ruin compounding, and rebalancing the portfolio in the face of changing needs/goals.
You can very well invest in mutual funds on your own. Just like you can fix your own plumbing, learn a musical instrument yourself, or self-study to get a degree. Paying for something depends on whether you need it and whether “value you get > cost you pay”. If you would like to outsource the work of money management and want guidance along the way, an MFD could be useful for you.
If you are someone that is looking for assistance and wants to work with a licensed MFD, please feel free to reach out and drop me a mail at rohanashok85@gmail.com or a message on Instagram @YoungIndianMoney.