Direct vs Regular Mutual Funds
One of the options that Mutual Funds offer investors investing in a Scheme is the choice of selecting if you would like to opt for a Direct Plan or a Regular Plan. A Direct Plan simply means that you invest in the scheme directly with the AMC without going through a distributor.
Regular and Direct Plans of fund schemes are exactly the same in all respects, except for one. The single biggest difference is that Direct Plans have a lower expense ratio (i.e. fees you pay the mutual fund), than regular funds. The two plans also have different NAVs as a consequence of the different expense ratios.
This is because when you invest in a direct plan, the AMC does not have to pay a commission to the distributors, and thus they do not charge distributor expenses/trail fees/transaction charges.
A lower expense ratio logically implies that direct plans provide higher returns when compared to regular plans. The returns can be differ from 0.5% to even as high as 2% for some funds. While this number might not seem like a lot, thanks to the power of compounding, the difference in returns generated over a period of time can be massive.
Let us understand how with a simple example:
Let us assume pre-cost returns of a mutual fund scheme is 10% and that the Regular Plan expense ratio is 2% while the Direct Plan expense ratio is 1%. So, the post-cost returns of the fund will be 8% and 9% for the regular and direct plans respectively. Let the monthly SIP amount be Rs. 5000/-. Let us now see the difference in returns generated by the two plans over a period of 20 years.