Back in 2012, SEBI had come out with several reforms which included the introduction of direct plans in mutual funds. Starting January 1, 2013, every mutual fund in India comes in two variants – a Regular Plan and Direct Plan. So, the question is, which plan is better for you: direct plan or regular plan?
Both versions are the exact same scheme, run by the same fund managers investing in the same stocks and bonds. The difference is that in case of direct mutual funds, there is no broker/distributor commission. Which means, as an investor, you get higher returns from the exact same mutual fund.
Let’s understand this in detail.
What Are Direct Plans of Mutual Funds?
Mutual fund’s direct plans are those mutual funds where asset management companies (AMC) or mutual fund companies do not charge distributor expenses, trail fees, and transaction charges. Their expense ratio is much lower.
Have a look at the difference in the expense ratio of some popular mutual funds.
|Fund Name||Expense Ratio – Regular Plan (%)||Expense Ratio – Direct Plan (%)|
|HDFC Small Cap Fund||2.37%||1.17%|
|SBI Bluechip Fund||1.97%||1.12%|
|L&T Short Term Income Fund||0.87%||0.52%|
|Indiabulls Liquid Fund||0.15%||0.05%|
*The expense ratio is as observed on 11th April 2018.
Due to this difference in the expense ratio, the resulting NAV of the same fund’s direct plan will be much higher. And the gap between the NAV of regular plans and the NAV of direct plans will only increase with time.
At the same time, the investment objective and investment mix of the scheme portfolio would be same for both direct and regular plans. Which means, the returns offered by the direct plan of a mutual fund will always be higher than the regular plan of the same mutual funds.
Let’s have a look at the regular and direct NAVs of the same mutual funds mentioned in the previous table.
|Fund Name||NAV – Regular Plan (Rs)||NAV – Direct Plan (Rs)|
|HDFC Small Cap Fund||46.058||48.575|
|SBI Bluechip Fund||38.4828||40.3471|
|L&T Short Term Income Fund||18.7371||19.0347|
|Indiabulls Liquid Fund||1692.9653||1701.6179|
*the above NAV is as observed on 11th April 2018.
You can clearly see, the NAV of the direct version of the same mutual fund is always higher. The older the fund, the higher the difference in NAV.
What Are Regular Plans in Mutual Fund?
Traditionally mutual funds have been sold through brokers and intermediaries. The commission that they earn by selling mutual funds is added to the expense ratio of the fund.
So, expense ratio largely has 2 components. One is the management expense which is the expense borne by the mutual fund themselves to run the funds. For example, fund manager fees. This expense is present in both regular plans as well as direct plans.
The second is the commission given to the distributor to distribute these funds. This commission is not present in direct plans. Only regular plans have this commission.
In a regular plan, mutual funds pay a sales commission to the middleman or brokers, who bring business for them.
The amount of commission varies between 0.5% – 1.25% per year. Although this amount is not reflected in your monthly statement, the NAV or net asset value of your mutual fund units get adjusted for this.
Who Should Invest in Direct Plans of Mutual Fund Schemes?
Everyone should go with direct mutual funds. Direct mutual funds give you higher returns than their regular counterparts.
Investors would get higher returns compared to regular plans. The returns would be higher by around 0.5% per annum depending upon the mutual fund’s expense ratio.
Hence, direct plans are good for investors who want to increase their returns by way of reducing the expense ratio. Lower cost of funds translates to higher returns on your investments.
Moreover, the higher returns keep compounding. That means that when less expense is deducted, your investment is worth more. That higher amount itself earns higher returns, and so on, over years.
So, we have seen from above, the debate around direct and regular plans usually revolves around 2 points:
1. Difference in returns
This can be substantial. The average difference in expense ratio between Direct and Regular Plans in 0.66%. While this number may not seem like a lot but this amount gets paid every year and with the power of compounding can balloon into a huge number over the years.
2. Value-add of the advice with regular plans
Professional financial advice is important and can make a big difference to returns. Mutual fund advisors can help you understand and manage your mutual funds much more effectively.
However, it is not necessary that you depend on a mutual fund advisor. If you can do your own research and understand mutual funds well enough, you can invest in direct mutual funds thus avoiding the services of a mutual fund advisor.
You could also hire an independent mutual fund advisor to advise you also.
So, it is obviously better to invest in direct plans for higher returns.
To look at some of the best performing funds from every category of mutual funds, check out Groww 30 best mutual funds to invest in 2018.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.