Every scheme in a mutual fund has 2 plans, namely regular and direct. There are majorly 3 distinctions if you compare direct and regular options – returns, NAV (net asset value) and expense ratio. To make an informed choice, you as an investor must ensure to understand how these 2 plans function and accordingly take a decision.
Expense ratio
The total expense ratio refers to the proportion of a mutual fund’s daily assets (net) used for mitigating its yearly operating expenditures. Their annual operating expenditures involve agent and sales commission, investment management costs, advisory charges, distribution expenditures, fund administration expenditures and marketing expenses. Though regular plan in a mutual fund is sold through distributors, brokers, and advisors in exchange for a commission, direct plans are directly sold to you by asset management companies or via online platforms without charging a distributor commission. Thus, the operating expenditure of a direct plan is usually 1 per cent less than its regular counterpart, which converts to a lower expense ratio for the direct plans.
Higher returns
Direct plans’ lower expense ratio infers higher returns. As savings in distribution expenditures remain invested in direct plans, it begins generating returns on its own owing to the power of compounding. While the difference in returns may be marginal in the starting years, over the long term it becomes considerable. For instance, if you invest constantly in a regular plan of the fund through an SIP (Systematic Investment Plan) an amount of Rs 20,000 for a span of 30 years at an annualised return rate of 12 per cent with 2 per cent expense ratio, then the overall corpus would be Rs 4.14 crore. However, if you invest the same amount in a direct option through the SIP of the same mutual fund with a 1 per cent expense ratio, your corpus over a period of 30 years would increase to Rs 5.17 crore. So, you will find a major difference in returns, which is Rs 1.03 crore where direct option in mutual fund has performed better than the regular plan by nearly 20 per cent over the long-term horizon.
Higher net asset value (NAV)
Direct plans come with a higher net asset value (NAV) than their regular counterpart owing to their increased returns. As the operating expense of the fund is reduced from its AUM (Assets Under Management), a lower total expense ratio of a direct plan would lead to a higher net asset value. Additionally, the difference in net asset value tends to become bigger because the compounding effect comes into power.
Ending note
Direct plans offer higher returns and lesser expense than regular plans. Over a considerably long investment term, the difference in returns over the long run will be substantial. However, you must hold some investment experience or knowledge to make an investment decision in a direct plan. This is because in case you make any incorrect investment, then you may end up negatively impacting your financial interest and standing. So, ensure to devote some time where you can monitor the investment performance and accordingly invest in direct plan.
