As per SEBI, mutual funds are categorized into two parts, namely direct and regular mutual funds. Direct mutual fund plans were introduced by SEBI in January 2013. This was done to allow investors to buy mutual funds without going through a middleman. Both direct and regular mutual funds are managed by the same fund manager and they invest in the same assets as well. But the main difference between them is that direct funds do not involve brokers while regular funds do.
What are direct mutual funds (Direct Plan)?
These are plans or mutual fund schemes that one can directly purchase from an asset management company (AMC), usually through their website. Therefore, in direct mutual funds, agents, brokers, or other intermediaries have to play no role at all.
The prospectus of these schemes normally will specify ‘Direct’ to help investors identify direct plans. Such plans can be bought through both online and offline modes.
Since no intermediaries are involved in direct mutual funds, this brings down the expense ratio as investors are free from any commission or distribution fees. For example, when you are directly dealing with a mutual fund company, they will not levy any transaction charges even when you start a SIP or make a lump sum investment.
Direct mutual funds will have a different Net Asset Value (NAV) from that of regular mutual funds. It is usually higher.
What are regular mutual funds (Regular Plan)?
These are those schemes of mutual funds that are purchased through a mutual fund broker, distributor, or advisor. Here, the fund house (Asset Management Company) pays a commission to the middleman for introducing a new investor to their plan(s).
AMC adds this commission to the expense ratio which means that it is recovered as an expense from the plan. That is why regular mutual funds are slightly more expensive than direct mutual funds.
In regular funds, extra charges are levied for the services that you take from an intermediary (agent, broker, or distributor).
Difference between direct and regular mutual funds
The main difference between direct and regular mutual funds lies in the payment of commission to brokers.
In a regular mutual fund, a sales commission is paid to intermediaries or brokers who get business for AMCs. This commission varies from 1% to 1.25% a year. Although your monthly statement doesn’t reflect this amount, the NAV of your MF units will be adjusted accordingly. Hence, your NAV will be lower in the case of regular funds.
On the other hand, under a direct mutual fund, AMCs do not pay any sales commission, so annual returns are generally 1% to 1.25% higher in the case of direct plans. In other words, the savings in expense ratio is passed on in the form of higher NAV.
The following table shows some points of difference between these two funds:
|Direct MF||Regular MF|
|The expense ratio is lower||The expense ratio is higher (due to the commission paid to the intermediary)|
|No advice/guidance is given||Advice/guidance is given|
|NAV is higher||NAV is lower|
|Research and market knowledge are required – Perfect for the market and investment savvy.||A qualified intermediary guides the investor as per the individual goals and risk appetite|
|Convenience is less||Convenience is more|
|More returns, as the expense ratio is lower||Lesser returns as the AMC fee is more|
At a glance, direct funds may seem to be a better option as they are cheaper. The difference in returns of direct and regular mutual funds is purely due to the commission paid to the middleman.
However, choosing a low-priced mutual fund may not always work to your advantage. You might need help in researching and selecting funds according to your requirements. In such a scenario, regular mutual funds may be a better choice. When you opt for a regular scheme, an intermediary understands your risk appetite and guides you accordingly. A regular mutual fund plan suits the best for investors who lack knowledge and time to monitor the market and portfolio. Such investors can get expert advice by paying a nominal fee. This small percentage of extra cost is worth making the right investment decision. Because compared to an uninformed wrong investment decision, a well-researched choice can give better value in the long run.
Example on returns difference
The returns of any direct mutual fund are always higher than the regular version of the same mutual fund. The return is higher due to a lower expense ratio in the case of direct plans.
For example, here is a comparison of the returns of SBI Bluechip Fund (regular plan) and SBI Bluechip Fund (direct plan.)
|Initial Investment amount||Rs. 10,00,000||Rs. 10,00,000||0|
|Investment tenure||5 years||5 years||0|
|Avg. 5 year return (annualized)||20.34%||19.24%||1.1%|
|Final return amount||Rs. 25,23,771.53||Rs. 24,10,515||₹ 1,13,256.53|
**Future Value = Present Value (1 + r/100)^n
Another example of comparing returns from SIP Direct plans and Regular Plans is as follows:
|Monthly SIP Amount||Rs. 10,000||Rs. 10,000||0|
|Investment tenure||10 years||10 years||0|
|Annualized return||9% (due to lower expense ratio)||8%||1.0%|
|Final return amount (corpus value)||Rs. 19,49,656||Rs. 18,41,657||₹ 1,07,999.93|
**FV (with monthly investments) = P [(1+i)^n-1]*(1+i)/i
i = r/100/12
n = 10 years*12 months
Factors to consider when choosing direct plans
We know that direct funds are easy in nature and the process of investing is simpler as they do not deal with a broker or intermediary. Here, investors don’t depend on a third party to make investments. Investors can directly invest and make investment decisions on their own. But before investing in a direct fund, one should determine the following:
- Whether the fund has offered good returns over a long period?
- Is the fund often not affected much by the market fluctuations?
- Check whether the expense ratio is lower when compared to the peer funds?
- Whether the fund offers a diversification of the portfolio?
- Whether the fund manager has an excellent track record?
Advantages of regular mutual fund plans
Below are some advantages that an investor gets in regular plans:
- Convenience in choosing funds that best meet investors’ goals and risk profiles
- The expert guidance of agents/distributors in picking the right investment portfolio
- Regular monitoring and reviewing of the portfolio performance and returns
- More investor-friendly than direct plans
Direct plans are less expensive and provide higher returns than regular plans. The difference in returns can be significant over a sufficiently long investment horizon. However, at the same time, direct mutual fund plans necessitate some investment experience and knowledge. If you make poor investment decisions, you may end up seriously risking your financial future. Hence, even if you end up getting lesser returns in regular mutual funds, at least your financial future does not get endangered because of wrong investment choices.