Mutual funds are broadly classified as investment vehicles where a pool of money is collected from various investors who want to put their money in the markets and is invested proportionally in the gains and losses of the fund.
There are two types of mutual fund scheme plans that investors can choose from - direct plans and regular plans. There are key differences in the plans that every mutual fund investor will have to go through and understand before investing in the markets. In this article, we will be covering the differences between a direct mutual fund plan and a regular mutual fund plan.
What are direct and regular mutual funds?
Direct mutual funds are offered by the fund houses directly without any involvement from third-party distributors. Regular mutual funds, on the other hand, are sold through third-party agents and distributors.
As investors are not directly dealing with the fund house while choosing regular mutual funds, commissions and brokerage charges tend to be involved in these funds. However, investors do not pay this commission to the agent, but instead to the fund house as an expense ratio and in turn, pays the agent.
History of the Direct Mutual Fund plan
Before 2013, you could purchase mutual funds only through intermediaries like agents, advisors, and third party-distributors, as there was a general consensus that the public lacked the financial awareness and knowledge to invest on their own. We call them regular mutual funds today where some percentage of the amount paid by the investor would be paid as commission to the brokerage firm by the mutual fund house directly.
However, the Securities and Exchanges Board of India (SEBI) had banned this practice as they did not want these mutual fund houses and asset management companies charging fees to investors for intermediaries.
Later on, in 2013, SEBI passed a new regulation giving direct access to the mutual funds from the houses without having to be charged for a commission from third-party distributors, what we call a direct mutual fund plan today.
Differences between direct and regular mutual funds?
The differences between direct and regular mutual funds can come down to a few key factors:-
The one factor we are all looking for before investing is the returns it can provide. Direct plans offer up to 0.5%-1.5% additional returns per year on mutual funds of the same fund house. This might not sound like much, but a difference of 0.5%-1.5% can compound to a massive sum many years down the line.
For example, if you invest ₹10,00,000 in a regular mutual fund plan at 15% returns for 10 years, your total corpus will add up to ₹40,45,557 at the end of the period. However, if you invested the same amount in a direct mutual fund at 16.5% returns for 10 years, your total corpus will add up to ₹46,05,314, an increase of over five and a half lakh!
Higher Net Asset Value (NAV)
Net Asset Value or NAV is defined as the result of total assets owned by the fund divided by the total number of units outstanding. These assets vary from bonds and debentures to company shares and derivatives.
Regular funds tend to have a higher expense ratio, and therefore have a lower NAV. On the other hand, direct funds save you from commissions and brokerage charges and as a result, have a lower expense ratio and a higher NAV than regular funds.
Avoiding poor choices of mutual funds
As you will not be relying on agents and third-party distributors for the purchase and handling of direct mutual funds, you are unlikely to be misled into choosing an offer that is not for you. Not all agents or distributors have to be honest and work in your best interests, a good percentage of them would be just interested in the largest commissions.
The same cannot be said for regular mutual funds. Agents are likely to have conflicts of interest or personal biases that can prevent you from being able to choose the best option.
It is clear to see that the lack of third-party distribution fees makes direct mutual fund plans much more profitable in the long run compared to regular mutual funds. It may be time-consuming to do your due diligence on researching the best mutual funds, but it will save you from a lot of hassle and lost amount to commissions over the years.