Direct mutual funds were introduced in India during the early months of 2013. Ever since then, there’s been a raging debate about what’s better - direct or regular mutual funds.
First things first, direct and regular plans of a mutual fund invest in the same stocks, bonds, and assets. They’re handled by the same fund manager and Asset Management Company (AMC).
However, there’s one thing that’s different between direct and regular mutual funds - the expense ratio. Many argue that it is the only aspect that matters when choosing between the two mutual fund variations.
In this story, we’ll put that theory to the test by exploring direct mutual funds, regular mutual funds, and the impact of the difference in expense ratio between the mutual fund scheme variations.
What Are Direct Mutual Funds?
Investors can buy direct mutual funds straight from a fund house (AMC) without a broker or intermediary. No third party involvement means that the AMC doesn’t have to charge a commission.
In any case, SEBI guidelines prevent fund houses from charging any commission on direct funds. That’s why the expense ratio of direct mutual funds is lower than regular mutual funds.
A lower expense ratio will bring down the overall cost of investing. But there’s more. No commission fees imply that the NAV of direct funds will be higher than regular funds.
You’ve more or less understood what sets direct Funds apart from regular funds. But the devil lies in the details. That’s why it’s important to understand why a majority of investors prefer regular funds.
What Are Regular Mutual Funds?
Regular mutual funds are offered by an intermediary like banks, advisors, and investment platforms. Fund houses pay the intermediaries a commission fee for selling their mutual funds.
Every fund house has to recover this commission fee in some way. They do that by charging a higher expense ratio on regular mutual funds. A higher expense ratio means that the cost of investing goes up.
By association, the NAV of regular mutual funds is lower than direct mutual funds. This has the potential to affect the returns, as the expense ratio can eat into the profits of an investor.
Differences Between Direct And Regular Mutual Funds
It’s important to note that direct mutual funds invest just like any regular mutual fund. In fact, direct and regular funds have the same portfolios, fund manager, and fund house. However, there are differences.
1. Expense Ratio
Direct funds have a lower expense ratio than regular funds because the fund house doesn’t have to pay commissions to a third-party intermediary.
Direct mutual funds are known to generate relatively better returns than regular mutual funds because of the low expense ratio. “Better” in this case is generally accepted to be approximately 0.5% to 1%.
Average Returns (5+ Years)
You’ll have to do your own research when you buy direct funds. This can be uncomfortable if you’re fairly new to investing or a busy professional.
Regular funds are distributed/curated by intermediaries and you can also get advice on which ones to buy and sell if you’re using an app like Cube.
Are Direct Funds Better Than Regular Funds?
Direct funds perform better than regular funds when it comes to:
Investment cost: No commission fees means a lower expense ratio
Returns: The lower expense ratio translates to marginally better returns
Direct funds don’t perform as well as regular funds when it comes to:
Level of research: An advisor or app can curate regular funds but you’ll have to do your own research for direct funds
The right fit: Intermediaries tend to recommend regular funds based on risk profile/investment goals
Extra perks: Intermediaries may offer investment tracking and review services that aren’t possible with direct funds
Who Should Invest In Direct Mutual Funds?
The introduction of direct funds had two broad implications. On one hand, direct funds are known to add more value to the returns that an investor can earn since the cost of investing is lower.
On the other hand, investors have to do their own research in order to buy direct funds. Now, this is not surface-level research that we’re talking about - it’s far more microscopic.
You’d have to look beyond star ratings and historical track records. At the same time, you’ll need to have an in-depth knowledge of macro trends along with your risk profile and investment goals.
Furthermore, a fund house can have hundreds of mutual fund schemes that you can invest in. The sheer volume of options alone can confuse even the most seasoned investors.
That’s why beginners are generally advised to steer clear of direct funds. Picking a fund on, say, popularity or trends alone can lead to a potential loss. This is where regular mutual funds come into the picture.
An app like Cube works with reliable experts like Wealth First who have a track record of beating the market by ~50% to help you access a handful of top regular mutual funds.
Wealth First does the research and recommends funds that can fit your investment goals and risk profile. Wealth First also advises on when to sell mutual funds. Doing all of this on your own would be cumbersome.
Ultimately, you’ll have to evaluate whether the trade-off between doing the legwork and low investment cost is worth it. Because there is a high chance of selecting the wrong direct mutual fund. That’s not all.
You’ll have to evaluate your understanding of the financial markets before investing in direct funds. The alternative is to invest in regular funds that are suitable for passive investors and busy professionals.
Watch this video to find out why you should never pick mutual funds on your own
Note: Facts & figures are correct as of 21-07-2021 and have been obtained from publicly available sources on the internet.
Shriram is a Consultant at CubeWealth. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. His love for philosophy, developing products, and empowering people through quality content is what got him to CubeWealth.
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