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Investors in mutual funds are often surprised to see that despite having the same asset management company (AMC), the same scheme name and exactly the same portfolio, there is a huge difference in the net asset value (NAV) and returns of its two different options—’Direct Plan’ and ‘Regular Plan’. When there is one fund manager and the same shares are being purchased, then why is there such a difference in the profits of both?
If you are also investing your hard-earned money in mutual funds through SIP or lump sum, then it is very important to understand the basic difference between direct and regular plans, because in the long run this difference translates into wealth worth lakhs of rupees.
What is the basic difference between direct and regular mutual funds?
There are two paths to any scheme in the mutual fund industry:
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Direct Plan: In this, no third person, agent, bank or broker is involved between the investor and the mutual fund company (AMC). You invest directly through the fund house’s official website, app, or through SEBI registered direct platforms (like CAMS, KFintech, MF Central etc.)
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Regular Plan: In this you invest through a Mutual Fund Distributor (MFD), agent, broker or your bank relationship manager. The intermediary helps you choose funds and handles your paperwork.
Same scheme, then why the difference in returns? Understand the expense ratio game
The only and biggest reason for the difference in returns of both the plans is-Expense Ratio and Distributor Commission.
The mutual fund house deducts a certain percentage from the total assets of the fund annually, called expense ratio, for managing the scheme, fund manager’s fees and administrative expenses.
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Additional commission in regular plan: When you take a regular plan, the fund house pays a lifetime trail commission to the broker or agent who sold you the fund. This commission is added to the expense ratio of the fund. As a result, the regular plan’s expense ratio is typically expensive, ranging from 0.50% to 1.50%.
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Zero commission in direct plan: There is no middleman in a direct plan, so the fund house does not have to pay commission to anyone. Its expense ratio is quite low.
Since the cost is less in the direct plan, the benefit of compounding (compound interest) continues on the remaining money, due to which the NAV and long term returns of the direct plan are always higher than the regular plan.
How big of a loss does a small difference of 1% cause in the long run?
Many investors wonder what difference an annual expense of 0.75% or 1% makes. Let us understand this with a practical example and mathematics:
Suppose you start a SIP of ₹10,000 per month for 20 years and the real annual growth rate of the underlying fund is 14%:
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In Direct Plan (13.5% Net Returns at 0.5% Expense Ratio): Your total investment after 20 years will be ₹24 lakh, and your total fund will be approximately ₹1.15 crore will form.
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In Regular Plan (12.5% Net Return at 1.5% Expense Ratio): Your total fund after 20 years will be approximately ₹99.9 lakh Only this will be possible.
With an additional commission of just 1%, you will earn approx. over a period of 20 years. More than ₹15 lakh May have to suffer direct loss. The longer time passes, the more stark this difference becomes.
Benefits of Regular Plan and who is it right for?
Despite the extra cost, the regular plan isn’t worth it for everyone. It proves to be quite useful for the following category of investors:
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Beginners and investors with non-financial background: People who do not understand mutual funds, asset allocation, large-cap, mid-cap or debt funds and cannot do the research themselves.
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Hand-holding and personal guidance: Those who need personal advice from a financial advisor or distributor to avoid panic withdrawals during severe market fluctuations or crashes.
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Time constraints: Investors who do not have time to review and rebalance their portfolio from time to time.
Benefits of Direct Plan and who should choose it?
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Financially Aware Investor: Who have a basic understanding of various mutual fund categories, risk profiles and fund performance.
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DIY (Do It Yourself) Investors: Who can choose the right fund themselves by reading the internet, apps and fund factsheets.
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Those seeking maximum returns: Those who do not want to lose even a single rupee of their hard-earned money in middleman’s commission and want to avail the full benefit of compounding directly.
How to switch from regular to direct plan?
If you have previously invested in a regular plan through a bank or agent and now want to switch to a direct plan, you can visit your respective AMC or online portal and choose the ‘Switch’ option.
However, when switching, keep in mind that technically it is considered selling the old fund and buying the new fund. Therefore, calculate the exit load and capital gains tax (LTCG / STCG) according to the holding period of the fund.
If you have financial savvy and a little time, Direct Mutual Funds are without a doubt the best and most cost-effective way to build your long-term wealth. If you are completely new and are comfortable paying an annual fee in exchange for professional guidance, then choosing a regular plan through the right distributor can also be a safe option.