Okay, let’s go back to the basics.
What is a mutual fund?
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A mutual fund is a type of financial instrument that enables the investors to pool their money together into one managed investment.
In simpler terms, mutual funds are like baskets where each basket holds certain types of stocks, bonds or a combination of stocks and bonds to form a portfolio.
In this article
Why Invest in Mutual Funds?
Because they are the simplest and easiest means of entering the capital market.
Also, the returns are superior when compared with other instruments such as a fixed deposit, recurring deposit, and the likes.
With higher returns, the funds bring in risk too. Depending on the type of instruments a fund holds, the risk level varies from low to moderate to high. There are two plans that are offered for each of the funds:
In this plan, an investor can directly invest in the fund scheme without involving distributors and/or brokers.
An investor can either visit the online portal of the fund house (asset management company or the AMC) or they can browse through any third party platforms such as Groww to start their investment.
Given that there will be no distribution fee involved, there wouldn’t be any transaction charges that will be debited at the time of subscription of a lump sum or systematic investment plan (SIP).
Under this plan, investors invest through an advisor and/or broker that are also known as distributors (intermediaries).
Thus, in this plan, the AMCs are required to pay a commission to the distributor. The AMC charges this commission to the investor and accordingly adjusts the Net Asset Value (NAV).
Which Is Better – Direct Plan or Regular Plan?
A direct plan is better for investors to get higher returns due to the reasons mentioned below:
1. Expense Ratio
The regular plan and direct plan of a fund will have different expense ratios (expense ratio is the annual cost of owning the mutual fund scheme).
The expense ratio of a direct plan is much lower because the money which would be paid as commissions to brokers is saved. In a direct plan instead, no commissions are paid out to anyone.
2. Net Asset Value
NAV of direct plans is relatively higher than regular plans. This does not mean that direct plans are more expensive.
This indicates that the saving in commission is added to the returns of the scheme and passed on to the investor in the form of a higher NAV.
3. Higher Returns
Investors get higher returns in a direct plan as compared to regular plan. The returns would typically be higher by 0.5% to 1.5% p.a. depending upon the expense ratio.
Example: When we compare direct and regular plans of HDFC Top 100 Fund (erstwhile HDFC Top 200 Fund), then we come to know that returns in the direct plan is more than the regular plan and the expense ratio is comparatively less in the direct plan i.e. 1.2% than in the regular plan i.e. 2.04%.
Performance in a Regular Plan:
Performance in a Direct Plan:
Thus, we see from the graphs above that the returns in the direct plan are higher by – Rs 1600. While this amount may look small today, do not forget that equity investment is a long-term investment and with compounding for a period of say, 10 years, the amount becomes sizeable.
It is better to invest in direct plans than in regular plans for higher returns, but this also requires more hard work from the investor, as he/she has to do the paperwork, shortlist a suitable fund and track the portfolio himself/herself.
Multiple fintech companies such as Groww have evolved in the space to enable an investor with a full-proof and simplified process of invest in direct funds. Should you wish to start your investing journey, feel free to connect with us.
Disclaimer: The views expressed in this post are that of the author and not those of Groww