Not many investors are aware but there are two kinds of mutual funds on offer – Regular and Direct plans and there is a significant difference between the two. What is the difference between Direct and Regular Mutual Funds? Why my “adviser” does not talk about Direct Mutual Funds? Why is there such secrecy regarding Direct Mutual Funds?
These are the questions that bother investors. In this article, we would try to address these questions but before jumping straight into the topic first we need to have a basic understanding of the structure of Mutual funds.
The mutual fund industry framework is also like any other industry i.e. it has a manufacturer (AMC), a buyer/customer (investor), and intermediaries (bank, distributors, IFA, etc).
Let’s take an example of any industry to understand it in a better way, say electronics. Let’s say Sony manufactures television sets. So a factory of Sony is somewhere manufacturing television at their manufacturing unit and then they pass on the stocks to distributors which eventually come to the showroom wherein the customers purchase the units.
Similar is the case with mutual funds, there is a investor and manufacturer, AMC in this case who devise various mutual fund schemes basis the strategies that they have adopted (like various models of television) and in between are the intermediaries(Banks, Broker, Wealth Managers, IFA, RIA etc).
For an investor to buy mutual funds either he has to approach an intermediary for executing the transaction (think of it as buying a television set from s showroom) but apart from that the mutual funds can also be bought directly from the manufacturer by avoiding the intermediaries hence it’s called a direct plan.
But the problem with the mutual fund industry is that due to lack of transparency and hidden interests these plans are not even told to investors (Yes, you guessed the reason right for it)
What is in the store for investors in a direct plan?
One has to understand that when you walk into the showroom and buy a television set, the showroom owner or distributor gets a commission out of every sale that happens similarly in mutual funds when you go to bank or any intermediaries they get a commission for every mutual fund that you buy you might not notice that because when you invest 1,00,000 the entire amount gets invested and it doesn’t seems to you that you are paying anything but the fact of the matter is you are and it is deducted from the NAV(Net Asset Value) of the fund.
There is a lack of awareness among the investors regarding such opportunities and the intermediary will never tell you such things as it’s a loss to him, rather he will scare you by telling you that you have to manage everything on your own, invest separately and struggle for service.
So, let’s first understand what the differential is for an investor when he opts for direct plan vs. regular –
The table1 shows the growth of 1 lakh INR over different periods of time ranging from 5 years to 30 years in a direct plan vs regular plan under the assumption that the differential of return is 1% (9% in direct and 8% in regular). Same is depicted in a graphical manner in the picture below. One can easily see that in a time of 5 year the difference is almost INR 7,000 whereas over a period of 30 year the differential is a staggering INR 3,20,502.00.16
So, what should an investor look for while deciding on direct or regular funds?
The answer is – Expense ratio –
The expense ratio is the total cost to the fund house for that particular scheme which includes the fund managers and research team salary, research cost, infrastructure, and commissions to intermediaries. You will be surprised to know that the difference between regular and direct maybe even up to 1.2% in some funds –
Look at the table below –
The table clearly shows the difference between the regular and direct plan. Even the fund like Franklin India Corporate Bond fund which is in Debt Category has a differential of 0.62%.
As an investor, it is very confusing to understand these minute but very important details and to select the right funds for oneself when there are people advising against the direct plan. It’s then when a SEBI registered Investment Advisor comes into the picture who is only a fees-based advisor charging nominal upfront fees and advising according to investors’ need and doesn’t have any incentive to push some products.