- Date : 16/11/2021
- Read: 8 mins
A new investor or one who doesn't have knowledge about mutual fund schemes has no choice but to start investments in regular mutual funds through a mutual fund distributor or another intermediary. On the other hand, knowledgeable investors who can manage their own investments can start investments in direct mutual funds. Both regular mutual funds and direct mutual funds have their benefits. In this article, we will discuss these benefits and which one an investor should choose.
When you compare the expense ratio of a regular mutual fund and a direct mutual fund, you will notice a small difference of 1%-1.5%. But, in the long run, this small difference in the expense ratio can make a big difference, running into lakhs of rupees in the amount you will accumulate. In this article, we will try to understand the difference between investment in direct mutual funds vs regular mutual funds and see which one investors should select.
What are regular mutual funds?
A regular mutual fund scheme is bought through a distributor. The distributor can be an individual mutual fund distributor, an organisation like a bank or broking firm, or an online platform. The distributor earns a commission for selling regular mutual fund schemes to investors. The commission is added to the overall expense ratio of the mutual fund scheme. It means that the investor is funding the commission indirectly, as the expense ratio is passed on to unitholders by charging it to the mutual fund scheme.
What are the benefits of regular mutual funds?
Some of the benefits of regular mutual funds are as follows:
a) Recommendations from a qualified mutual fund distributor
When you avail of the services of a qualified Mutual Fund Distributor (MFD), they will help you identify and quantify your financial goals, analyse your risk profile, make a proper asset allocation plan, and accordingly recommend regular mutual fund schemes for investment. So, a qualified mutual fund distributor will help you do financial goal planning systematically rather than just recommending regular mutual fund schemes for investment.
b) Smooth implementation of the recommendations
Once the MFD recommends the regular mutual fund schemes based on your financial goals, they will help you move ahead by starting a Systematic Investment Plan (SIP) in the mutual fund schemes. The MFD will help you complete your Know Your Customer (KYC) process if you are investing for the first time. Once the KYC is completed, the MFD will help you with the form-filling process for starting the SIP in the mutual fund scheme.
Related: Dummies Guide To Mutual Funds
c) Regular review of recommended schemes
The MFD will review the performance of the recommended regular mutual fund schemes once every six months or yearly. They will analyse whether the performance of the schemes is on track to meet the financial goals on time. If a particular regular mutual fund scheme is not performing as expected, the MFD will replace it with another scheme.
The regular mutual fund schemes recommended by an MFD will entail a higher expense ratio. But, as long as the services of an MFD help you meet your financial goals, they are worth it, even if they result in a slightly higher expense ratio.
What are direct mutual funds?
In 2012, SEBI mandated all mutual fund houses to introduce two variants of every mutual fund scheme - regular and direct plans - from 1 January 2013. A direct plan can be bought directly from the AMC or an online platform. It does not pay any commission to the distributor. As a result, the expense ratio of a direct plan is lower than that of the regular plan of the same mutual fund scheme.
The NAV of a direct plan is always higher than that of a regular plan. As a result, you will earn higher returns from a direct plan than a regular plan of the same mutual fund scheme.
What are the benefits of direct mutual funds?
Some of the benefits of direct mutual funds include:
a) Low expense ratio
The biggest benefit of direct mutual funds is the lower expense ratio. As there is no MFD involved, there is no commission to be paid. And, as there is no commission to be paid to any MFD, the expense ratio of a direct mutual fund is lower than that of a regular mutual fund.
b) Higher NAV and higher returns
We have seen in the earlier section how the expense ratio of a direct mutual fund is lower than that of a regular mutual fund. Due to this, the NAV of a direct mutual fund is always higher than that of a regular mutual fund. As the NAV of a direct mutual fund is higher, the returns of a direct mutual fund are always higher than that of a regular mutual fund.
Comparison between regular mutual funds and direct mutual funds
Difference in amount accumulated due to a higher expense ratio
If you have good knowledge of mutual funds and are clear on which mutual fund scheme to invest in, you should go for a direct plan. Even if you don’t have good knowledge of mutual funds and are not sure which mutual fund scheme to invest in, consult a fee-only financial advisor. You can seek their advice on which mutual fund scheme to invest in and go for the direct plan of that scheme.
A 1% difference in the expense ratio between the direct plan and the regular plan of a mutual fund scheme can significantly affect the final amount you will accumulate. For example, Raju and Kiran invest Rs 25,000/month in the same mutual fund scheme for 30 years. However, Raju invests in the regular plan, and Kiran invests in the direct plan of the scheme. At the end of 30 years, this is how much Raju and Kiran will accumulate.
As seen in the above table, Raju will accumulate Rs 5.17 crore and Kiran will accumulate Rs. 6.46 crore in 30 years. Kiran will make an additional Rs. 1.29 crore due to a lower expense ratio. So, the 1% difference in the expense ratio has made a difference of Rs 1.29 crore in the final corpus of Raju and Kiran.
Difference in returns of direct and regular plans of various schemes
In the above section, we saw how a difference of 1% in the expense ratio of the scheme's direct and regular plan could make a big difference in the final amount accumulated. Let us now see the returns given by direct and regular plans of various mutual fund schemes.
(Source: Paytm Money)
The above table shows the difference in returns over 5, 10, and 20 years due to the difference in the expense ratio of a regular and direct plan of the same mutual fund scheme.
Regular funds vs direct funds: Which investor should choose which type of fund
So far, we have understood what regular and direct funds are, their benefits, differences, and returns. Finally, let us understand which fund should be chosen by which type of investor.
a) Regular mutual funds
Regular mutual funds are for new investors or those who don't have the time to do their research on various mutual fund schemes. These investors can take the help of an MFD or another intermediary. The intermediary can help with step-by-step comprehensive financial planning rather than just selecting regular mutual fund schemes. The intermediary can also help with regular review of the recommended regular mutual fund schemes and handhold the investor till the financial goals are achieved. For an investor who doesn't have knowledge of mutual funds, it is okay to avail of the services of an intermediary who gets a commission.
Investors who don't know about mutual fund schemes also have the option of availing of the services of a fee-only financial advisor. The financial advisor can help you with your comprehensive financial planning and recommend mutual fund schemes for investment. You can then proceed to invest in direct plans of these mutual fund schemes.
Related: Factors To Consider Before Switching From Regular Mutual Funds To Direct Mutual Funds
b) Direct mutual funds
Direct mutual funds are for those investors who have knowledge of mutual fund schemes. Investors who have already finalised the mutual fund schemes for investment can invest in direct mutual funds. These investors usually have the capability to review the performance of schemes regularly and take corrective action if and when required.
As an investor, whether you go for regular mutual funds or direct mutual funds, your ultimate goal should be to achieve your financial goals. As a new investor, you can always start by availing of the services of an MFD and investing in regular mutual funds. Over time, as you gain knowledge of mutual fund schemes and feel confident in managing your investments, you can switch to direct mutual funds. The other option is to avail of the services of a fee-only financial advisor and invest in direct mutual funds right from the beginning. Whichever path you choose, make sure you achieve the ultimate goal of fulfilling your financial goals.
Disclaimer: This article is intended for general information purposes only and should not be construed as insurance or investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.