Guide to investing in Mutual Funds through SIPs

I wish to invest in mutual funds through SIP. However, I am confused by the various schemes and plans available, such as direct versus regular plans, open- and closed-end funds, and IDCW options. Could you provide a comprehensive overview of the different schemes and plans and the available payout options? – Paul

An open-ended mutual fund is like a metro smart card. You can enter anytime, exit anytime and reload whenever you want. There’s no fixed “start or end date,” and you transact (buy/sell units) at the current NAV. Most SIP investors prefer open-ended funds for flexibility and ease of access.

Remember that you need to pay an exit load, which is a small fee charged if you withdraw your money before the stipulated time (one year in most cases). Think of it like a “penalty for early exit” meant to discourage short-term trading. Once the exit load period is over, you can exit freely with no charge.

ELSS fund

Equity Linked Savings Schemes (ELSS), also open-ended in structure, come with a mandatory three-year lock-in period for claiming tax benefits. During this period, you cannot redeem or exit from your investment.

After three years, it behaves like a normal open-ended equity fund with full liquidity.

Closed-ended fund

On the other hand, a closed-ended mutual fund works similar to an IPO for stocks. It is launched through a New Fund Offer (NFO), which is usually announced via advertisements or other avenues for a limited period only. You can invest only during this offer period, just like applying for an IPO.

Subsequently, the fund is closed for new investments from the AMC side. Note, most apps or direct AMC websites offer open-ended SIPs mostly.

Direct vs. regular plans

Now, let’s understand the difference between “direct vs regular” plans. Imagine buying the same product in two different ways: directly from the manufacturer or through a local shopkeeper. The product is exactly the same in both cases, but the price structure differs. Similarly, in mutual funds, a direct plan means you invest directly with the Asset Management Company (AMC), while a regular plan involves investing through an Association of Mutual Funds in India-registered (AMFI) mutual fund distributors. These brokers must have an ARN number to legally sell mutual funds.

In regular plans, the intermediary earns a commission that is built into the fund’s expense ratio, which is usually higher than direct plans.

This slightly reduces your overall returns compared with direct plans, wherein there is no middle layer and therefore lower costs. As a result, a larger portion of your money remains invested and continues to grow. Therefore, most self-managed SIP investors choose direct plans, which are generally better for retail investors due to its lower expense ratio.

IDCW option

IDCW stands for Income Distribution cum Capital Withdrawal. In April 2021, SEBI renamed the ‘Dividend Option’ in mutual funds to IDCW to better describe how the payouts work. If you previously invested in a mutual fund under the Dividend Plan, you will now see IDCW in your account statements instead.

IDCW payments may be made from the income earned by the mutual fund, such as dividends received from stocks or capital gains from selling investments. That is, the payouts can come from the fund’s profits or by returning a part of your invested capital, thereby reducing the fund’s Net Asset Value (NAV).

Put simply, IDCW is not extra income or a bonus, but a portion of your investment being returned to you. Investors seeking long-term wealth creation should generally choose the Growth option. Those who need regular payouts from their investments may consider the IDCW option.