Did you know that the first mutual fund in India was set up way back in 1963? That’s nearly 60 years ago! However, it wasn’t until 1987, that the mutual fund market really started to grow. Back in the day, investing via mutual funds was a novel concept, and this gave rise to a unique sales model. That’s where the difference between a Regular Plan versus a Direct Plan for mutual funds originates. And that’s what we are going to discuss today.
The Sales Model for Mutual Fund Investing
Mutual fund houses (aka Asset Management Companies or AMCs), had come up with the beautiful investment product of mutual funds, but there was almost zero awareness around it. So, instead of reaching out to retail investors like you and me directly, these mutual fund houses assigned distributors to do the job on their behalf. The distributor would be the one to educate investors about mutual funds and get them to invest.
For this service, the mutual fund house would give the distributors a commission for every investment made by their investors. The commission paid would be an expense for the fund house, which the latter would then recover from us investors. This went on for 50 years.
Then, in 2013, SEBI (the Securities and Exchange Board of India) introduced something called Direct Mutual Funds.
Direct vs Regular Mutual Funds
Regular Funds
As discussed so far, mutual funds under the Regular Plan are shorthanded as Regular Funds. And these are funds that involve a commission. For instance, let’s say you have your own mutual fund advisor or broker. The advisor or broker has their own broker code and is registered with SEBI. The commission that the broker receives for his or her services might seem small, approximately 1% of your total investment. However, in the long run, this small amount adds up to quite a big number.
What difference does 1% make you ask
The difference of expense ratio between a regular and direct fund is 1% on an average. In some cases it may be 0.2 % and sometimes as high as 1.65%. Let’s consider a simple example, you start a SIP of Rs. 10,000 and continue investing for 10 years. Let’s assume the return as 15%. The total investment would be 12 lacs.
With an expense ratio of 1.5% 12 lacs would become 25.42 lacs.
With an expense ratio of 0.5% 12 lacs would becomes 27.02 lacs
That’s a difference of Rs. 1.6 lacs.
Direct Funds
When SEBI introduced mutual funds under the Direct Plan, aka Direct Funds, the intention was to give the well-informed investors an opportunity to directly purchase the mutual funds from the fund house. And thus, eliminate the middleman and save on commission. SEBI directed all the mutual funds schemes to have a direct plan as an alternative option. Investors who wish to invest directly can now do so. With increasing awareness about the world of investing, thanks to the internet and with numerous RIA applications like Zerodha, Groww and Paytm, investments in direct plans have been steadily increasing. (RIA stands for Registered Investment Advisors. RIA can be an individual or investment firm that follows a fee based model for providing advisory service to its clients). As on 31st March 2021, more than 16% of the equity mutual funds market comprises direct plans.
How do I know whether my mutual fund is direct or regular?
You can check the mutual fund statement to find out whether the plan is direct or regular. If you have invested through a distributor, it will be a regular plan. But that doesn’t mean that all investments made via applications are direct. Since some of these applications act as distributors instead of RIA, and offer only regular plans.
Should one shift from regular to direct?
If you are well educated about the basics of investing, you can definitely go for direct plans. In case you have any regular plans, the first step would be to stop further investments in those schemes, and start a fresh direct plan for the same schemes.
What about the existing regular funds? It is possible to switch them to direct as well through the website and also physically. However, doing so may attract capital gains tax, since switching from one plan to another is considered as selling and purchasing as per the income tax laws.
Our Take
Needless to say, direct funds are better than regular ones. And if you keep yourself well-informed via websites like Value Research and understand the risks involved, Direct Funds are always the go-to option when put next to Regular Funds.
