Chalking out the differences between regular and direct mutual fund: Which one to include in your portfolio?

When investing in a mutual fund, there are various things you have to consider. You have to pick between equity and debt funds and you also have to choose between making a lump sum investment or opting for a Systematic Investment Plan (SIP). These are important decisions that determine how your investment pans out. Another essential thing you should consider is whether you should pick direct vs regular mutual funds. The difference between these two plays a critical role in the kind of returns you earn. But first, let’s understand the meaning of these funds.

Direct vs regular mutual funds

Direct and regular mutual funds are two ways to invest in the same mutual fund scheme. The scheme is the same in terms of its fund objective, investment strategy, fund manager, asset allocation, and load structure. But there is one significant difference between direct and regular mutual funds and that is the involvement of intermediaries.

In a direct mutual fund, you directly invest through an Asset Management Company (AMC) or a mutual fund house. You can do this either online through their website or offline through their branch. There is no third-party agent involved in this transaction – it's just you and the AMC. Conversely, in a regular mutual fund, you buy the same scheme but through an intermediary such as a distributor, broker, or advisor.

If you are wondering why this difference between direct and regular mutual funds matters, that’s because when a third-party agent is involved, there is an element of commission. The AMC pays the agent a commission that it ends up recovering usually from the expense ratio of the mutual fund. As a result, the cost of investing in mutual funds goes up for you as an investor. But to really understand this difference between regular and direct mutual funds, let’s first look at what an expense ratio in mutual funds is.

What is expense ratio and how does it matter in regular vs direct funds?

All mutual funds come with their own expense ratio, which includes several costs that the AMC incurs in running the fund. The expense ratio includes management fees, allocation charges, advertising costs, operating costs, etc. One of the significant costs that it covers is the commission or the brokerage fees paid by the AMC to the distributor, which is responsible for the key difference between regular & direct mutual funds.

The expense ratio in mutual funds is expressed as a percentage of your investment. What’s important to note is that this is not a charge that you will have to pay separately annually. Instead, it is automatically deducted from your returns. The daily Net Asset Value (NAV) of the fund that you see arrives after having deducted the expense ratio.

The expense ratio for mutual funds differs depending on the Assets Under Management (AUM) and the type of fund ranges from 0.5% to 2%. When you consider direct vs regular mutual funds, the expense ratio of regular funds will inevitably be higher because of the commission. Since direct mutual funds have no intermediary, there is no commission cost to cover.

The expense ratio of regular mutual funds is usually 0.5% to 1% higher than that of direct mutual funds. It might not seem like much but over the long term, it may convert into a significant amount of money. This is not the only difference between regular & direct mutual funds.  

Differences between direct and regular mutual funds

  • Guidance

The major advantage a regular fund has over a direct fund is that the distributor or advisor who serves as the intermediary provides guidance. This can be helpful if you do not have sufficient investing knowledge to decide for yourself which fund to pick or if you don’t have the time to monitor the performance of the fund.

  • Control

The flip side of the guidance is that sometimes there may be agents who will push certain mutual fund schemes because of vested interests and not because the scheme is aligned with your financial goals. This is not the case with direct mutual funds where you are in full control and make the decision of which mutual funds you want to invest in and how you want to manage that investment.

  • Returns

Regular vs direct mutual funds’ returns are not the same even though it is the same scheme. The returns of direct mutual funds are higher than that of regular mutual funds because of a lower expense ratio.

  • NAV

Again, the NAV of regular vs direct mutual funds is different due to the expense ratio. Direct mutual funds have a higher NAV than regular mutual funds.

Direct vs regular mutual funds: Which to pick?

It might seem like when considering direct vs regular mutual funds, it’s financially more prudent to pick direct mutual funds because of the lower expense ratio that translates to a higher NAV and higher returns. However, you should also consider if you can individually assess and select the right mutual funds for your investment portfolio. In fact, in India, only 22% of equity mutual funds are direct funds, as per industry estimates.

If you are clear about your financial goals, risk appetite, and investment horizon and are aware of how to evaluate mutual fund schemes to pick the ones best suited for you, you should consider direct mutual funds. It’s convenient to directly invest in the mutual fund online through the official website of the AMC once you’re sure of the scheme you want to invest in.

But if you are new to the world of investing and are still learning the way the markets work, you might want to consider regular mutual funds for now. The value you will gain out of the services of the intermediary may justify the higher expense ratio you will be paying.

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