Direct vs Regular Mutual Funds

  • Aaditya Sridharan

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.

It can be seen that though slowly initially, the excess returns generated increase exponentially due to the power of compounding. From the 11th year, you lose more money in regular plans than the amount you are investing in the form of SIPs. Eventually, at the end of 20 years, a 1% difference in annual returns leads to a massive Rs. 4,23,440/- difference in the maturity amount. Most companies that sell you Regular Plans of Mutual Funds and claim to provide their services FREE of charge, are actually robbing you of these additional returns on your portfolio. Our assumptions on the expected returns and the variation in expense ratios are on the conservative side, and in reality, there is an even bigger difference in the maturity amount. Further, logically, as the SIP amount is increased, this variation in returns will also increase. Thus, Direct Plans are clearly a much better investment option than regular plans. However, many small investors are still stuck with the high cost regular plans. This is largely due to lack of awareness. Even those who know that direct plans are cheaper than regular plans often do not switch to the former as they are unaware of the extent to which a direct plan can increase their overall return. We hope that reading this article has enlightened you to some extent on the benefits of Direct Plans.

Aaditya Sridharan

Aaditya Sridharan is an engineer by degree, but an analyst by heart. He is incredibly fascinated by the markets and the potential they hold for any intelligent investor. He hopes to help people realize the true potential of their wealth and change the norm of keeping the savings in a bank account that is prevalent in the country.