Direct vs regular mutual fund schemes: Know the difference in returns over 10 years

Investing directly in mutual fund schemes is a popular choice among investors as they look to maximise returns by minimising expenses. On the other hand, regular mutual fund schemes might be suitable for investors who prefer personalised assistance and guidance from intermediaries.

This piece will explain the difference between direct and regular mutual funds schemes and if it’s worth listening to expert advice, and what factors to consider while investing.

Direct mutual fund scheme: In this scheme, you invest directly with the mutual fund company, bypassing any intermediaries such as brokers or distributors. “Investing in direct plans means you’re dealing directly with the fund house, which typically results in lower expense ratios and fees. Since no intermediaries are involved, the returns earned are generally higher than regular mutual fund schemes,” says Rajiv Bajaj, Chairman and MD of BajajCapital Ltd.

Regular mutual fund scheme: In a regular mutual fund scheme, you invest through an intermediary, such as a broker or distributor. These intermediaries provide advice, assistance with paperwork, and customer support. However, they also charge commissions and fees, affecting your returns over time. Bajaj says, “The expense ratios in regular mutual fund schemes tend to be higher due to these additional costs.”

The difference in the corpus: Let’s say you invest Rs 15,000 per month in a direct mutual fund scheme SIP and a regular mutual fund scheme SIP for 10 years. Due to the lower expense ratios in the direct scheme, your investments are likely to yield higher returns over time compared with the regular scheme. While the exact difference in the corpus will depend on various factors, including the fund's performance and market conditions, it’s generally expected that the direct mutual fund scheme would result in a larger corpus than the regular mutual fund scheme.

Comparison between direct and regular mutual funds schemes performance

Aniruddha Bose, Chief Business Officer of FinEdge, says, “Direct plans have an expense ratio that’s lower by roughly 0.6–1% compared to their regular plan counterparts. Hence, they can deliver higher returns on paper than regular plans. To put this in perspective, a mutual fund SIP of Rs 15,000 a month that grows at 12.5% in a direct plan will grow to Rs 35.5 lakh in ten years, compared to Rs 34.5 lakh if it grew at 12% in a regular plan instead.”

Bose said, “The reality is that investing without expert assistance (for most investors) can cost them a lot more than Rs 1 lakh over 10 years. This is evidenced by the high SIP stoppage rate in direct plans over the years whenever markets turn volatile - ironically, the best time to keep your mutual fund SIPs running. Finally, published returns do not matter - earned returns do!”

“If you invest in regular plans, investors should rightfully question the value that incremental 0.5% can get you. Can it get you an investment expert who manages investments and investing behaviours, brings in the best of tech, and inculcates investing discipline through robust processes and best practices? We know we are our own worst enemies when it comes to investing. The difference between meeting our goals or succumbing to fear and greed can be from the value we derive from the incremental 0.5% we pay. It’s true that going direct reduces commissions, but it also often compromises on advice, tech, processes and purpose. The question that begs an answer is - are you investing to save commission or to meet your goals?” adds Bose.

Thus, one must understand that investing in a mutual funds scheme is not easy. Santosh Joseph, Founder of Germinate Investor Services, says, “There is equity, debt, hybrid and also international and many sectoral funds. You cannot go at it to pick a scheme; you must understand what it entails. It begins with choosing the asset and then the combination of asset classes. Second, you will also like to go for an established company you are comfortable with. For example, you may want to part your money as an investment to companies that you are comfortable with that have a lot of good processes, have a good team and have got, at some level, a good track record of performance not only at scheme level but even at a company level, they have a 10-20 year history, they got a good stable team, they also got some good funds, and they also have many investors already invested with them with a tried and tested process.”

Here are some factors you must consider while investing in mutual funds

When investing in mutual funds, there are several important factors to consider making informed and effective investment decisions. Here are some critical factors for you to keep in mind:

Investment Objective and Goals: Clearly define your investment goals and objectives. Are you seeking long-term wealth accumulation, regular income, or a combination? Your goals will help you choose the right type of mutual funds that align with your financial aspirations.

Risk Tolerance: Assess your risk tolerance level. "Different mutual funds carry varying levels of risk. Determine how much volatility you are comfortable with and choose funds that match your risk profile," said Bajaj.

Fund Category and Type: Mutual funds come in various categories, such as equity, debt, hybrid, and thematic funds. Select the category that best suits your investment goals and risk tolerance. Additionally, consider whether you want actively or passively managed index funds.

Past Performance: While past performance does not guarantee future returns, it can provide insights into a fund’s track record. Compare a fund’s historical performance against relevant benchmarks and peers to assess its consistency and performance during different market cycles. Joseph said, “You also have to, at some level, look at the underlying portfolio, the recent performance, the way they have done during good times and bad times. This will only happen during a slightly longer window of the fund's track record.”

Expense Ratio: The expense ratio represents the fund house’s annual fees and operating costs. Lower expense ratios can positively impact your overall returns, especially over the long term.

Fund Manager: A skilled and experienced fund manager can play a crucial role in a fund's performance. “Research the fund manager’s track record and investment approach to gain confidence in their ability to manage the fund effectively,” said Bajaj.

Portfolio Holdings: Examine the holdings within the fund's portfolio. Diversification across different securities and sectors can help manage risk. Make sure the fund's holdings align with your investment objectives.

Exit Load and Tax Implications: Be aware of the exit load (fees charged for redeeming the units within a certain period) associated with the fund. Additionally, understand the tax implications of investing in different types of mutual funds, as taxation varies based on factors like fund category and holding period.

Investment Horizon: Determine your investment horizon—the time you plan to stay invested. Different funds are suitable for different timeframes. “Longer investment horizons may allow you to take advantage of compounding and tolerate market fluctuations,” said Bajaj.

Systematic Investment Plan (SIP): Consider using SIPs to invest regularly and systematically. SIPs can help you benefit from rupee cost averaging and reduce the impact of market volatility.

Transparency and Disclosures: Evaluate the fund house's transparency in providing information about fund performance, holdings, expenses, and other important details. Look for funds that provide clear and comprehensive disclosure.

BT’s take

Investors should remember that mutual fund investments should align with your overall financial plan and risk tolerance. Diversifying your investments across different asset classes and funds is a good practice to manage risk effectively.