Direct Mutual Fund Vs. Regular Mutual Fund: Penny Wise and Pound Foolish

Mutual funds are one of the best tools to multiply your wealth by diversifying your portfolio amongst different asset classes. Each mutual fund provides two options to their investors:

1. Direct Plan

2. Regular Plan

Direct mutual fund plan

Investors were not allowed to trade directly in mutual funds before 2012. Securities and Exchange board of India introduced the concept of direct mutual funds in 2012. When an investor purchases unit of mutual funds from any fund house directly i.e., without the help of any intermediary, then this plan is known as direct mutual fund plan. In simple words, investors visit the website of a fund house and then buy units of mutual funds directly thereby eliminating the role of third party all together. Investors devote a lot of time in planning their financial goals and in researching on the suitable mutual fund product by themselves in order to pick the right fund at the right time. Since investors are buying funds themselves, there are no brokerage and commission in direct fund plan. Expense ratio is lower and therefore investors save that much in expenses it does not guarantee higher returns. Investors are allowed to purchase units either through offline or online mode.

Regular mutual fund plan

When investors purchase units of mutual funds with the help of intermediary then these are known as regular mutual fund plans. Brokers, advisors and distributors play a crucial role in regular plans since investors trust them with their money. Intermediaries are better equipped with resources and put their expertise into use in order to generate more returns for investors. Fund houses pay fees/commission to intermediaries for selling their units. Expense ratio is marginally higher for regular funds than direct funds. Mutual fund distributors and advisors are experienced investors having a lot of financial wisdom therefore investors who do not have time to study about markets can rely on these distributors and advisors for earning higher returns from mutual funds. Paying a nominal fee for expert advice is worth of the returns you would be getting by investing in the suggested funds.

Difference between direct and regular mutual funds

Returns

For a given mutual fund scheme, returns on direct option are marginally higher than regular option to the tune of fraction of expenses cost. Direct funds save expenses typically 0.25% to 0.5% because of absence of charges like fees and commission. The wrong perception that Direct gives higher returns than Regular attracts a lot of investors who take risks of investing in direct mutual funds by following herd mentality which often leads to huge losses.

Expense Ratio

There are certain expenses which are incurred by funds houses to manage investors’ money. Expenses are higher in regular plans since intermediaries are investing their time to pick the best funds for you. As per SEBI, investors do not have to pay any fees or charges while investing. Therefore, the expense ratio is slightly lower in case of direct mutual funds. The fund houses still charge the expenses for managing the funds and the only saving is on the intermediary cost.

Net Asset Value (NAV)

Net asset value (NAV) represents the per unit market value of a fund and it is calculated by subtracting the liabilities from the total assets and then divide the whole amount by outstanding unit on the particular day. Mutual funds are traded in units. Hence, NAV for direct funds will be higher since no extra fees is getting deducted. However, any wrong bet by novice investor while investing can mean losses therefore investors have to be really careful while investing in direct mutual funds. Please feel free to go to this link if want to read about NAV in detail - https://sipfund.com/blog/Net-Asset-Value-of-Mutual-Funds.html

Why regular mutual funds weigh over direct mutual funds?

Time is money

Investing in a Direct mutual fund is a time taking and cumbersome process. Regular mutual funds have reliable and experienced advisors or a team of mutual funds analysts and researchers who are using their expertise and knowledge to multiply investors’ wealth. Investor’s time is getting saved and they can utilize their time on their job and enterprise unlike direct plan where investors are going through rigorous process of picking up the right stock. Hence, investing in regular plan is much more convenient than direct plans.

Experienced Mutual Fund Distributors

Mutual fund distributors and experts have a deep knowledge about the functioning of mutual funds products and they know which kind of products will suit the investors having different financial goals. They can easily assess investor’s financial statements and choose the best combination of funds which can provide higher returns in future. Besides picking up the right funds, a mutual fund distributor or advisor can become a financial guide to investors by imparting mutual funds knowledge to them in their investment journey. So, investors can enjoy professional advice while investing through regular plan whereas direct plan does not have these kinds of benefits. There is a high chance of bet going wrong while investing through direct plans since decision is not backed up by a professional.

Shield against market shocks

Since markets are dynamic and internationally linked, there are so many factors that affect the returns of mutual funds. It is really difficult for an investor to keep a track on market movements regularly therefore they may not be able to restructure their portfolio when there are impending jitters. Hence, investors investing through direct plan can be on the losing sides in unfavorable market situations. On the contrary, a regular plan has intermediaries who can easily keep a track of the market through their deep insight and advanced tools and can immediately restructure portfolio if requires.

Ad on services

When investors invest through regular plan in mutual funds then they get additional services like advice on tax saving schemes, help in tax filling and assistance at the time of redemptions also. These services are not for investors who are investing through regular plans.

For the table it can be understood that:

1. The Number of SIP Accounts and AUM in Regular Plans are far higher than the Direct Plans which shows the investors’ confidence and preference of investing in mutual funds through the intermediaries for hassle-investments and earning higher returns on their investments by utilizing the support and expertise of the intermediaries.

2. Investors who have preferred Regular Plans have been continuing their investments for a long term, say 5 years and more and obvious they will get much benefits from the power of compounding due to longer time horizon. This long-term investing by the investors is also due to the timely support and advice they get in the Regular plans on their portfolio that make them less worried about their investment choice and let their money grow by following the expert suggestions.

Conclusion

In case of direct mutual funds investor still bears the cost of fund management charges by fund houses and has nobody to advice if an invested non performing fund will ever bounce back. In such cases, mutual fund distributor will give an unbiased opinion and advice on changing the fund. Historically all the funds have had good return periods and bad return periods. A direct scheme investor could end up in long bad return fund periods for long time and end up switching between one poor fund to another poor fund. With the help of Mutual Fund Distributors, a regular scheme investor can take timely switching decisions and get higher returns. This timely tweaking of funds will only cost you 0.25% to 0.5% in a full year which is a miniscule price to pay to get good returns.

By investing in direct scheme investor indeed saves this small commission to mutual fund distributor but the risk of losing higher returns could be in the range of 5-8% per year in typical equity scheme. In direct debt scheme, it could also mean funds being stuck due to default by underlying borrower of a scheme, whereas a good Mutual Fund Distributor will advise you timely exit.

There is a European saying, “Penny wise Pound foolish” which implies that someone can be very careful or mean with smaller amounts of money but wasteful and extravagant with large sums.

The choice is between incurring a miniscule cost and getting better returns due to expert advice and saving pennies and ending up risking your capital.

Investors should be careful with larger amounts in order to get wealthy over longer period of times. By paying a minimal brokerage or commission for availing the expertise of the intermediaries, investors can accumulate more wealth by choosing to invest in Regular Mutual Fund schemes.

Happy Investing!