Direct vs Regular Mutual Funds - What's the Difference?
Today, Mutual Funds are emerging as a go-to investment option for salaried employees and self-employed professionals. By putting the law of averaging to work, Mutual Funds can help you earn substantially more for a given amount of money compared to traditional favorites like Fixed Deposits.
As an average investor, you may not track the market closely and thus need to rely on a broker or distributor's expert advice. Regular Mutual Fund plans are ideal for you. On the other hand, those of you who are familiar with the market typically pick your own funds by approaching the Mutual Fund company directly. These plans are called direct plans. Therefore, both regular and direct Mutual Funds have their uses and appeal to different segments of investors.
However, there are certain differences in each that you need to be aware of. For example, the expense ratio may vary between direct and regular plans. Compared to direct plans, regular plans can have up to 1% higher expense ratio. However, it must be remembered that the amount charged by Mutual Funds towards their administrative expenses is regulated by the Securities and Exchange Board of India (SEBI).
What is expense ratio?
Like any other business, Mutual Funds have to pay for routine expenses such as salaries, advertising, commissions and taxes. These expenses are deducted from their earnings (also known as Assets Under Management (AUM)). Thus, the ratio of the cost of managing a fund to its annual revenues is termed as expense ratio. It is a key differentiator for investors looking to buy Mutual Fund units.
What are the factors responsible for the difference in Mutual Fund expense ratios?
In regular plans, Mutual Fund houses or Asset Management Companies (AMC) need to partner with intermediaries like brokers and distributors to grow their market share. Needless to say, AMCs incur significant costs by way of commissions to develop a large distributor network in a country the size of India. This is in addition to the recurring costs of managing day to day business operations. Taken together, these administration costs constitute the Total Expense Ratio (TER) of the AMC. Distributors too have to bear routine expenses towards marketing, sales and customer support, all of which affects their margins and, by extension, business viability. This affects the expense ratio of regular plans.
On the other hand, direct plans do not cost the AMC as much as there is no third party involved between them and the end-customer, you. The difference in terms of ROI for investors can be quite substantial. For example, if you invest Rs 6,000 in a ‘regular’ monthly SIP with an expense ratio of 2%, your corpus would be Rs at the end of 25 years. 1.20 crores. On the other hand, the yield from a direct plan with the same amount invested but at an expense ratio of 1% would be 17.2% higher- Rs. 1.45 crores.
While regular plans may appear to be the better option, a cost-benefit analysis must assess the real returns that you stand to gain, especially since Mutual Fund investments are subject to market risks. So, the risk factor should not be overlooked when deciding which is better of the two.
Let's take a look at some of the pros and cons of direct plans versus regular plans:
It is no surprise that direct plans potentially offer better returns compared to regular plans. Without the added burden of third-party commissions, fund managers can pass on the profits earned by the fund to investors to a greater extent. However, SEBI regularly monitors Mutual Fund expense ratios to protect investors from arbitrary practices. Some distributors like HDFC Bank also publish scheme-wise commission structure for the various funds they sell.
Higher Net Asset Value (NAV)
NAV is the current market value at which each unit of a fund sells. As an investor, you pay an amount equal to the NAV to purchase units from the fund. It is also the price at which units can be redeemed when you exit the fund upon maturity. Direct plans do not have to share their profits with intermediaries, which positively affects higher NAV terms. This means that the compounding effect is much greater and consequently you can earn up to 1% more than regular funds.
Risk factor concerning investment decisions
In a direct plan, you can switch between various funds based on your financial needs. This can help you get better returns. However, if you are relatively new to investing, it also increases the risk you are exposed to. Any losses on account of speculative choices are solely the responsibility.
The advantage of investing in regular plans is that professional fund managers manage your portfolio to maximize your returns over a period of time. This means that the odds of earning better returns is relatively higher. But the onus of doing the due diligence and closely tracking fund performance to ensure the right fit for your needs is yours when you invest in direct Mutual Fund plans.
Fortunately, there are plenty of online resources available today that you can use to validate your investment decisions.
At a glance, the difference between direct and regular Mutual Fund plans is as follows:
Type of Plan
Commission to brokers
No commission is payable as brokers are not involved
Commission varies from 1 to 1.25% of the maturity/redemption value
The expense ratio is comparatively lower
The expense ratio is comparatively higher
The potential for returns is higher compared to regular plans
The potential for returns is lower compared to direct plans
The risk is higher as the investment decisions rest with the investor.
The risk is lower as the fund managers make all investment decisions on your behalf.
It is comparatively higher
It is comparatively lower
The benefits of scale are often ignored when it comes to investing in regular plans. By spreading costs over a large pool of investors, large Mutual Fund distributors like HDFC Bank reduce investors' cost burden. Combined with a wide range of equity and debt plans, HDFC Bank also offers you the convenience of trading through NetBanking or a dedicated Investment Services Account (ISA). If you are looking to invest in the debt market, we also offer RBI bonds and 54EC bonds. HDFC Bank is committed to complete transparency and regulatory compliance. Any changes to the service terms and conditions- such as transaction fees or account maintenance charges are intimated to customers, in line with bank policy.
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* Terms and Conditions apply. The information provided in this article is generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. You are recommended to obtain specific professional advice from before you take any/refrain from any action.