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Direct vs regular mutual funds

Back in the year 2012, SEBI had come out with various changes and introduced a direct plan for mutual funds. With impact from January 2013, every mutual fund comes with two alternatives: A regular plan and a direct plan. In this article, we will discuss about Direct vs Regular Mutual Funds.

These are two alternatives of a similar mutual fund. This is overseen by a similar fund manager who invests in the same bonds and stocks.

The main difference between the two plans is, fund house pays a commission to the intermediary/specialist as a distribution fee. Though, in the case of a direct plan, no such charges/commission is paid. 

 

What are Direct Mutual Funds?  

Sebi Mandated All AMCs (Asset Management Companies) to launch a direct plan for direct investors, from 01 January 2013. This kind of plan has a low expense ratio as it excludes the distributor expenses and commission. No commission is to be paid from such a plan. The Direct plan has a separate NAV. So Now all Mutual Fund schemes have two plans- Direct and Regular. In a Direct plan, an Investor invests with the AMC directly without any distributor to facilitate the transaction. 

Direct vs Regular Mutual Funds

What are Regular Mutual Funds?  

Regular mutual funds are those plans that are bought through a mutual fund broker, distributor, or advisor. For every regular mutual fund scheme, the AMC pays a commission to the distributor. The AMC adds the commission of the advisor to the expense ratio. It makes regular funds slightly more expensive. Extra charges in regular schemes are for the services that you avail from an intermediary you buy from. Apart from the services, the investor also receives the advice in order to identify the fund or scheme to invest in. 

 

Direct vs. regular mutual funds

Both the plans – direct and regular are managed by the same mutual fund manager and the investment is also made in the same assets.

In direct plans, AMCs do not pay any sales commission. The Direct investor also has invested his time and effort in order to select the mutual fund scheme and making an ideal portfolio for himself. 

On the other hand, regular plans are commission-based they have a higher expense ratio but investor receives expert advice. So, if one particular scheme started at the same time and ends at the same time as well, the direct plan will give higher returns compared to the regular plan. But it should also notice that in a regular plan investors could have received better advice in fund selection. A financial advisor can save plenty of time by picking the best plan to suit the investor's requirements.


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Comparison of returns from Direct and Regular Plan

Below we have taken the example of one mutual fund scheme and we can analyze the difference between them. 

Here we can analyze that how can direct plan gives better returns to an investor. In the above example investment amount, tenure and annualized returns are absolutely the same but since the expense ratio is different in regular and direct plans, the final corpus in hands of the investor creates a huge difference. 

Direct vs Regular Mutual Funds

Explanation of direct investment - Mr. B started a sip in a particular scheme of Rs. 25000 each month for a period of 30 years. He invested 90 lakhs (25000*12*30). After 30 years he received 6 crores 46 lakhs so Mr. B gained 1.29 crore more than Mr. A. This only contains the AMCs expense which is around 1% in equity schemes. 

 Explanation of Regular investment- Mr. A also started sip in the same scheme of 25000 each month for a period of 30 years. His cost is 90 lakhs and after 30 years his investment generates only 5 crores 17 lakhs. This has a 2% Expense ratio as it not only contained the AMC expense, but also the fees of the fund manager.

 

Direct vs regular mutual funds - Which one to pick?

In general, it looks very easy to understand that which plan one should pick for the better returns but the catch is… 

1. Stock market volatility- For the new investor who wants to start his investment in mutual funds or in the capital market, it is never been an easy path. The stock market is very volatile hence there is no straight line or fixed 10%/12% or 15% returns. There are times when investor also faces negative returns during a short period of time (up to 5 years of sip investment may generate negative returns). 

2. The decision in the panic situation- So, an individual who chooses a direct plan may stop his further investment or he may withdraw his amount accumulated in a mutual fund. This happens because of negative returns generated by the equity schemes and in bad times mutual fund returns look not attractive comparative to bank FD. 

3. Goal-based planning- It is very important that every investor must decide their goal before investing. There are different schemes to select for different goals. One should choose the mutual fund scheme as per their investment horizon. If the investment horizon is for long term (5 years or above) then only we should go for equity schemes, if the investment horizon is for short term (1-2 years) or medium-term(2 to 3 years) then we should select liquid funds or short-term debt funds respectively. 

Direct vs Regular Mutual Funds

Benefits of Direct and Regular Mutual Funds?  

Direct and regular both the plans are equally important and they both are beneficial for the investor. 

Here we understand the benefits of them one by one. 

Direct plan benefits:

  • Low Expense Ratio - As there is no intermediary involved between the investor and fund house, the expense ratio of direct funds would be lower than the regular funds. Since regular fund AMCs pay commission to the agents for their services and they recover these expenses through expense ratio they add in a regular plan. 
  • Higher NAV - The Net Asset Value (NAV) of a mutual fund is the ratio of the value of the total asset in its portfolio of the number of outstanding units. Since there is no brokerage in the direct plan, the NAV of the direct plan would be higher than that of the regular plan. 
  • High Returns - No brokerage or commission involved in direct funds, the expense ratio of the direct funds would be lower. Hence in a short period of time (1 year), it may not appear a big difference but in a longer period, it would create a massive difference in returns of both the plans. 

Regular plan benefits: 

  • Expert Advice - A qualified/certified Advisor can guide you in picking the right investment portfolio. They also help you in decision making while choosing important financial goals for your life, so that investors can make better Goal planning as per their individual requirements.
  • Comfortable and smooth transactions - Ease of doing transactions is benefit is with the agent or distributor. It is very easy to select the funds to submit them via physical or it is online. For new investors, it is mandatory to make a KYC of the investor. Since the distributor has experience of doing the transactions it is a comfortable and smooth process as far as the transaction is being submitted.
  • Monitoring - Investment in mutual funds may not be the task for the investor. Example – A well to do businessman or an employee MNC who would have many things to do to get his job done, may not be able to spare time for his investments to monitor on regular basis. Hence the advisor does this job on the investor’s behalf to monitor and review the investments and guide the investor accordingly if it needs any changes.
Direct vs Regular Mutual Funds

Direct vs. regular mutual funds – Suitable for what type of Investors  

Direct mutual fund- It is better if an investor has the necessary knowledge and understanding of capital markets, for analyzing the performance of the schemes. Also, they need to allocate time to do these activities. Investors with these abilities will be able to invest directly through an AMC as well. 

Regular mutual fund- Those who do not understand the risks involved and cannot keep track of fund performance, it is best to invest through a regular plan. It is always better to pay some commission fees than losing a chunk of invested capital due to miscalculated moves. 

 

Conclusion  

If you are making a goal-based investment in a mutual fund, and do not have the necessary experience or comfort with making such financial decisions. It is always recommended to invest through an experienced and skilled advisor with a dedicated team to make such decisions for you. And you can avail of this through a regular plan. 

On the other hand, a direct investor who has complete knowledge of mutual fund investment and understanding of the capital market can enjoy 100% of the benefits of his/her investments. Moreover, it can lead to a huge difference over a period of time. Because even a difference of 1% can be a huge gap with the compounding effect in the long-term. 

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