Direct Mutual Funds have been gaining popularity among retail investors since 2013. Today, they account for a large part of the new investments coming into the mutual fund sector. In this article, we nail down the key difference between direct and regular mutual funds.
What is covered in this article?
What are direct plans in mutual funds?
A direct plan is when you directly approach the mutual fund company and purchase units on a mutual fund scheme. This means, there are no distribution expenses that the company needs to incur in direct mutual fund plans. This savings are then passed back to investors as lower expenses.
On the contrary, a regular plan is when investors go through an agent or distributor. This advisor then assists the investor in choosing the right fund and helps with the paperwork. Against such efforts, the distributor needs to be compensated. The mutual funds company does that by baking the distributor’s commission into the expense ratio. Thus, the expense ratio of a regular fund is higher than a direct fund.
In the above example, we see the difference in expense ratio between the direct and regular plans of Aditya Birla Sun Life Frontline Equity Fund. The direct plan has an expense ratio of 1.17% while the regular plan has an expense ratio of 1.97%.
This means the cost of distribution for Aditya Birla Sun Life Mutual Fund is 0.80%. This is generally the difference in direct and regular funds for equity funds. The difference is much lower for debt funds and the least for liquid funds.
For a comprehensive article on systematic investment plans, don’t forget to read up my article titled The Complete Investor Guide to Building Wealth with SIPs
Prefer to watch a video instead? Here’s a simple informative video from Nitin Kamath – the CEO and founder of Zerodha. He goes on to explain the differences between regular and direct mutual funds
Do read my article on the benefits of mutual fund SIP and let me know what you think in the comments section
Incorrect advice given by some financial advisors
Unfortunately, some mutual fund advisors have been giving incorrect advice to get clients to opt for regular funds as opposed to direct funds. Here are some techniques used to hoodwink beginner investors –
- Buy regular because it is available at a cheaper NAV
- The difference in NAV is only in the first year. Post that, all expenses are the same from the second year onwards
It is beneficial for the beginners investor to understand the facts behind these statements.
1. Regular funds come at a lower NAV than direct funds
As opposed what some financial advisors say — regular funds are actually not cheaper, they are more expensive. Let’s understand with a simple example.
You invest an amount of ₹10,000 with a mutual fund. Now, the mutual fund needs to keep some money for its expenses and invest the rest in the stock market.
In case of direct funds, the mutual fund keeps 1% while in our example, it keeps 2% in case of regular funds. Hence, the amount available for investment in case of –
- Direct funds = ₹9,900
- Regular funds = ₹9,800
So if lower money is going towards investment, as is the case with regular funds, lower will be the potential returns on the regular funds. It’s that simple.
In terms of the NAV, if the mutual fund is breaking the units into 100 parts, then –
- Direct part of the fund goes at an NAV of ₹99
- Regular part of the fund goes at an NAV of ₹98
As seen above, the NAV is merely optics and it doesn’t hide the fact that less of your money is being invested in case of regular mutual funds.
2. The difference in NAV is only in the first year
And then all expenses are same from the second year onwards is totally incorrect. Some cunning financial advisors use this tactic to allay expense objections from investors. The take advantage of the fact that most investors would not bother to check.
Regular funds continue to price in the distribution expenses. Mutual fund distributor who retails regular funds will continue to get a cut from the overall investor AUM
To put some math.
Case 1 – You invest ₹10,000 every month in a regular mutual fund SIP for 20 years & receive a 12% annual return
Case 2 – You invest ₹10,000 every month in a direct mutual fund SIP for 20 years & receive a 12.5% annual return (the expense is lower by 0.5%)
This extra 0.5% cut in returns adds up to ₹7 lacs lost if you invest ₹10,000 every month in a regular mutual fund SIP as compared to direct mutual funds.
Where did this money go? Well, it goes to your financial advisor who has made a total commission of almost ₹7 lacs on that regular mutual fund SIP.
More precisely, the financial advisor would have made ₹6,95,196 in commissions from you.
Need any more reason to shift to a direct mutual fund?
Choose the direct route over regular for SIP investments
Overall, it is highly beneficial for the investor to invest via direct funds and not regular funds.
As a result, I would suggest all your investments especially SIPs, should be made in direct mutual funds only. That’s because the incremental 0.8% can make a world of difference in what you will earn when you retire.
So the next time, you start an SIP – dont forget to go direct!
Let’s have another quick example to put the above into perspective.
Let’s say, you invest ₹10,000 every month for the next 30 years in an SIP which is giving you a return of 12.00% in regular plans and 12.80% in direct plans. Then, here is how the difference will play out –
SIP on Regular Mutual Fund
- Investment = ₹10,000 per month
- Term = 30 years
- CAGR = 12.00%
- Total Amount Investment = ₹36,00,000 (i.e. ₹10,000 * 12 months * 30 years)
- Total Wealth Generated = ₹3,52,99,138
SIP on Direct Mutual Fund
- Investment = ₹10,000 per month
- Term = 30 years
- CAGR = 12.80%
- Total Amount Investment = ₹36,00,000 (i.e. ₹10,000 * 12 months * 30 years)
- Total Wealth Generated = ₹4,22,47,992
As a result, your direct mutual fund SIP gained an additional ₹69,48,854 — or 1.93 times of the total money that you have invested (1.93 * 36 lacs)
Look at it another way — you are paying your financial advisor ₹69 lacs in investment fees just for helping you choose a fund and doing the paperwork. A bit too much, isn’t it?
Be smart. Switch to direct.
Now, you can do this very easily by using fintech platforms like ETMONEY, PayTM Money, Groww etc. who have a switch feature.
Additional Resources You Might Like
- 5 Steps process on how to start SIP investment online
- The best SIP plans to invest in 2020
- Top SIPs for long term investing
- Complete Investor Guide to Building Wealth with SIP
- SIP Calculator