Why is the expense ratio of direct funds lower?

Mutual fund schemes are usually categorized into - Direct and Regular Plans.

Both these plans are exactly same, as in they are run by the same fund managers. The funds in both the plans are invested in the same stocks and bonds, making the portfolio essentially the same.

The difference lies in the fact that direct mutual funds charge no broker/distributor commission and other charges.

On the other hand, regular mutual fund schemes charge broker or intermediary fees or commission. This is because usually mutual funds have been sold through brokers and intermediaries.

This commission is added to the expense ratio of the fund making it more expensive than the direct plan.

The commission usually amounts to 1% – 1.25% per year.The difference can be observed in the NAV and returns of the 2 plans.

It must be noted that expense ratio of a fund contains expenses like the fund management fees (mostly, fund managers salary) which is present in both direct and regular plans. Over this, regular plans also charge broker fees.

Therefore, all things remaining same, it is safe to say that in a direct plan, investors gain higher returns vis-à-vis regular plan, due to lower expense ratio. You can read more here.

The expense ratio of any mutual fund consists of these broad categories: distribution charges, securities transaction fees, management fee, investors transaction fees and fund services charges.

In case of direct mutual funds, the expense ratio does not include the distributions charges. This results in the expense ratio being much lower.

For example, the expense ratio of SBI Bluechip Fund (Regular) is 1.97%. But for SBI Bluechip Fund (Direct), the expense ratio is only 1.15%.

This can result in big differences in returns over a long period of time.

The returns received from direct plans will always be higher than the returns received from the regular plan of the same mutual fund.