The expense ratio of a direct plan is usually around 0.5-1% lower than the regular plan of the same mutual fund.
Many first-time investors simply do not understand the difference between the regular and direct plan of a mutual fund. There is practically no difference between the two as they invest in exactly the same stocks, bonds, etc. Their fund managers, exit load, minimum investment amount, and most other details are also the same. But, there is only one key difference between them. A difference that has a big impact on returns. Direct mutual funds always give higher returns because they have a lower expense ratio.
Expense ratio is the fee the mutual funds take from you for managing your investments. This is usually between 0.5% and 2.5% of the total amount invested. The rate is applicable yearly. It consists of the fund manager’s fee, marketing fee, audit fees, distributor’s commission, etc. The expense ratio is deducted before your returns. So the returns you see are actually what you get. There is no need to pay any fees afterwards.
The expense ratio of a direct plan is usually around 0.5-1% lower than the regular plan of the same mutual fund. Go ahead and check it out. Search for any mutual fund’s regular plan and look at its expense ratio. And then, check out its direct plan’s expense ratio. The direct plan’s expense ratio will always be lower. This results in you always getting higher returns.
You might be wondering now, if direct plans are exactly the same as regular plans, and yet offer higher returns, why do regular plans even exist? Earlier, there was no direct plan. Only regular plans used to exist.
You see, earlier, mutual fund investments were done via distributors or brokers. There was no online option. Distributors arrange all the paperwork for you, submit the forms, track the purchase and redemption of your investments, teach you about investments and so on.
These distributors get a commission from the mutual fund companies for every investment. This commission comes from the expense ratio. So you are indirectly paying a commission to the distributor.
But the problem with this model is that the distributor’s commission is paid every year, not just the year you invest. So even though the distributor is not helping you much after the initial investment, he continues taking a cut from your investment.
Many investors felt they did not need the services of distributors. So they wanted to avoid paying a commission. By doing so, they would be able to get a higher return on their investment since the commission would not be deducted. Besides, distributors often suggest mutual funds that earn them higher a commission instead of suggesting mutual funds that are good for the investor.
Seeing this, SEBI (Securities and Exchange Board of India) asked all mutual funds to introduce direct plans in 2013. And since then, every mutual fund has both a regular plan as well as a direct plan. The expense ratio in case of the direct plan of a mutual fund does not have distributor’s commission. Hence, it is lower.
These days, there are several online options using which you can invest online. It has become so simple, no paperwork is involved at all. You can do everything on your own within minutes.
This isn’t to say that all online options offer direct plans. Carefully check if the mutual fund on an online platform is the direct plan or regular plan. If it is a direct plan, it will be mentioned in the name of the mutual fund. Example, ‘HDFC Small Cap Fund - Direct’.
As for learning about mutual funds, there are several very good blogs that teach you about mutual funds and investing. Many other channels very regularly give top recommendations, too. So you can easily learn and make informed decisions. Educating yourself about mutual funds puts you in the driver’s seat of your investment. Besides, there are various online communities on social media where many experienced and new investors interact, learn, and get recommendations from each other.
Many people often do not realize the difference here. They think the slightly higher expense ratio will not impact their investments. This is not true. If you start an SIP of Rs 5000, in about 2 years, you won’t see a big difference in the returns you get. But over a period of 15 years, the difference could be as high Rs 5-6 lakh.
At this point, the choice is very simple. In the present day scenario, there are enough ways to learn, understand, and invest without the help of a distributor. It really does not make sense to invest in regular mutual funds for any investor whether they’re new to investing or are experienced.The writer is the co-founder & COO of Groww.inGet access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.