Direct Mutual Fund: Check its Features & Advantages

Mutual Funds have emerged as one of the top choices of retail investors in our times. Be it through tax-saving ELSS, foresighted SIPs, or just lump sums, everybody is into mutual funds in one way or more.

Mutual funds are not new. They have been there for more than 30 years. However, increasing incomes over the years, reduced bank deposit rates, the demand of the market, and awareness among investors have led to the immense popularity of mutual funds as an investment instrument.

Just as mutual funds have finally found their foot, there has been a lot of discussion going around on which plans to opt. Each mutual fund comes with certain options. It may be a ‘direct’ or ‘regular’ plan. It could be one of the ‘growth’ or ‘dividend’ plans. 

In recent times, Direct Mutual Fund plans are gaining traction over Regular Mutual Fund plans. With all the advertisements and advisors around, people either get too confused to pick or too confident to pick one blindly. By the end of this piece, you should be able to make an informed choice for yourself.

The Direct Mutual Fund Plan

What are the ways one can buy a mutual fund? Either you can have an advisor or a broker who can buy it for you, or you can buy it directly from the fund house. When you directly buy a plan from the fund house, it is called a ‘Direct plan’. If you go through the broker route, it is known as ‘Regular plan’. 

Suppose you buy a mutual fund through a broker. If the broker would buy something for you, he would have his cut. When the fund would have made its gains, there would be a share of your earnings going to your broker as well. Though this commission (included in the expense ratio) seems to be a very small amount, in the long run, it does affect earnings by a lot.The absence of this commission is the reason why direct plans are getting popular. Otherwise, the entire management, fund and rest other aspects are the same.

Expense Ratio of Direct vs. Regular Mutual Funds

Each mutual fund charges some expense. This cost is reflected in the expense ratio of the mutual fund. Understanding things in numbers, for a regular plan, since broker is also a part, the expense ratio is as high as 1.89%. On the other hand, for a direct plan, where there are no middlemen between you and the fund house, this ratio might range as low as 1% to 1.5%.

The difference in returns of Direct & Regular funds

The returns of funds are analysed using CAGR (Compounded Annual Growth Rate) when the span of investment is over a year. Returns of direct plans are always higher than returns of regular plans. You would see the difference caused by the lower expense ratio. However, the difference in CAGR will not be much. 

The difference in CAGR between the two kinds of plans may be as low as 0.02% to as high as 1.5%. However, in most funds, you would see it around 1% (0.95%-1.05%). This seems to be a minuscule difference. In fact, the advisors would try to convince you with the same argument.

However, what they do not tell us is that this 1% is a ‘compounded’ annual growth rate. It means that if this extra 1% is compounded over say 20 or 25 years, it would actually make a huge difference in your earnings. For instance-

Say you buy a mutual fund worth ₹ 1 lakh. Here is the difference in earnings.

As you can clearly notice, direct mutual funds will make such a huge difference over longer periods.

The popularity of Direct Mutual Funds

Direct Mutual Funds are bought for the same reason as above. Since you are buying it, no advisor can fool you. Importantly, there is a lot of transparency.  Many do-it-yourself platforms have come up and they have made the process very easy. Fund houses have themselves come up with their mobile applications to avoid the middlemen between the fund and investors.

Direct mutual funds used to be just 7% of total investments in mutual funds in 2015. By March 2020, they now boast an impressive 45% share. They have seen a huge inflow from high net worth individual (HNI) investors. Efforts from fund houses, app development companies, and the Association of Mutual Funds in India (AMFI) campaign of “Mutual Fund Sahi Hai” would only push this further.

Are Direct Mutual Fund plans invincible?

Direct Mutual Fund plans have no issues with them per se. However, one must understand that direct plans are designed to cater for those who have a good understanding of mutual funds. It is for those who can analyse the growth, the returns and then compare funds on their own. 

For new investors, or those who do not want to get into the intricacies of funds should go through a regular plan with help from a trusted advisor. It is just like learning to drive. You need to have someone by your side to help you judge the situation, and later when you get better, you may drive alone.

The other issue is with fund houses. Their representatives tend to blabber vast differences in the returns (as high as 5%). The ‘regular plan’ and ‘direct plan’ both work the same way. The difference is just the annually recurring expense. The difference is not more than 1.5% in most cases. Therefore, always look at the numbers yourself rather than believing their words. 

In addition, since the returns are higher, the demand is higher. The price or NAV for Direct Mutual Fund plans will always be higher than its corresponding Regular Mutual Fund plan. So there you are.

The Bottom Line

Direct Mutual Fund plans are great. They do create a difference in the long run of 20 years or more. However, new investors should be cautious. There is no haste and this is not the competition. When you already plan to invest in something that is new to you, you are already a hero.

Test the waters, and only then, dive deep.

Invest wisely!