Do you know that the same fund, managed by the same fund manager and investing in the same portfolio, can give you different returns?
This sounds surprising, right? But this is exactly what happens when you compare regular and direct plans on the same mutual fund scheme. The underlying investments and fund manager can remain the same, but the two plans show differences in expense ratios. That’s the difference that actually affects the returns investors receive.
Even a gap of 1% may be significant when you calculate long-term returns. Let’s understand how the 1% effect can create a difference in your portfolio when you stay invested over years.
Regular vs direct mutual fund – What is the difference?
A mutual fund scheme can allow investors to choose between regular and direct plans. These plans have the same investment goal, and the underlying portfolio remains the same. Both plans are managed under the same scheme by the fund manager. However, the key difference lies in how they are accessed by investors.
In a regular plan, an investor purchases the mutual fund through a distributor or intermediary. The mutual fund house pays a commission to the distributor, which is reflected in the expenses under the scheme.
You can purchase a direct plan from the mutual fund house directly, and no distributor is involved as an intermediary. As no commission for the distributor is factored in, the expense ratio is lower for a direct plan than that of the corresponding regular plan.
This difference in expenses can affect the net asset value (NAV), and consequently, the returns that investors receive. When you compare regular vs direct mutual funds, look at the cost structure and identify the difference in expense ratios.
Why can the same fund give different returns?
The expense ratio is one of the reasons why the same fund can give different returns in its regular and direct schemes. The expense ratio is used to manage the costs associated with operating the mutual fund. These expenses are charged to the fund and are reflected in its NAV. As the expense ratio reduces the return generated for investors, a lower expense ratio can leave more of the gross return of the fund with the investor.
How does a 1% difference become significant over time?
Over a long investment tenure, the effect of compounding becomes more significant. Even a 1% difference in expense ratio can create a sizable difference in terms of returns.
Suppose you keep ₹5 lakh invested for 20 years, and the annual return is 10%. Let’s check how a regular scheme (Plan A) and a direct scheme (Plan B) perform.
| Plan A | Plan B | |
|---|---|---|
| Initial investment | ₹5 lakh | ₹5 lakh |
| Gross annual return | 10% | 10% |
| Expense ratios | 1.5% | 0.5% |
| Approximate annual return after expenses | 8.5% | 9.5% |
| Value after 20 years | ~ ₹25.6 lakh | ~ ₹30.6 lakh |
A small difference of 1% can, therefore, create wealth of around ₹5 lakh after 20 years. This potential gap can grow over time, as the money that remains invested also compounds. So, when you compare all mutual funds, consider a fund with a reasonably lower expense ratio, along with strong performance.
Does a lower expense ratio always mean a better mutual fund?
A lower expense ratio doesn’t necessarily mean that a mutual fund is better. Cost is an important factor, but it shouldn’t be considered the only priority when you choose a mutual fund.
Other important aspects to consider are the investment goal of the fund, portfolio composition, risk level, performance across different market cycles, and suitability for your financial goals.
For instance, a low-cost fund may not be suitable for you if its investment strategy doesn’t match your investment horizon or risk tolerance. The same applies when you choose between regular and direct plans. An investor who wants assistance from a distributor while selecting funds may go for a regular plan.
A direct plan, on the other hand, may appeal to investors who are comfortable with researching funds and managing their investment themselves. Therefore, you need to look into other aspects than simply examining the expense ratio.
How should investors compare mutual funds and their plans?
When you compare mutual funds, consider the investment goal, portfolio composition, risk, and volatility along with the expense ratio. The historical performance of the fund and other costs like exit load also matter.
Expense ratio
Check the expense ratio of the fund, or the assets of the fund that are charged towards expenses. This difference can be particularly relevant when you compare regular and direct plans of the same scheme.
Investment goal
Study the investment goal of the fund and understand what it is designed to invest in. This investment objective should match your own investment goals.
Portfolio composition
Evaluate the securities held by the fund and the level of concentration across different sectors or companies.
Risk and volatility
Considering your risk tolerance, assess the volatility of the fund. Conservative investors may choose comparatively stable mutual funds.
Historical performance
Look at the performance of the fund over different periods and market conditions. The latest return over one year doesn’t reveal much about its long-term performance.
Other applicable costs
Check the exit load and other charges that may apply, depending on the fund and transaction.
Make sure to compare the regular and direct versions of the same scheme to understand the impact of costs. This will help you gain a clearer picture of the differences in returns over the long term.
Conclusion
The regular and direct schemes under a mutual fund scheme can be managed by the same fund manager. Even if they are designed with the same investment goal and have the same underlying portfolio, the returns received by investors can differ. That’s why investors should review the expense ratio while choosing the mutual fund scheme. A gap may look small over one year, but it becomes more visible over a long investment period due to the effect of compounding.
As an investor, your goal is to choose the right scheme under the same fund depending on whether you can research yourself or want to involve a distributor. It’s not that one plan is better than the other, but understanding what you are paying and the support you receive during the process.
That’s how the cost becomes a part of your long-term investment strategy. For a more informed choice, compare both costs and the suitability of the fund for your portfolio.
Note to the Reader: This article is part of Mint’s promotional consumer connect initiative and is independently created by the brand. Mint assumes no editorial responsibility for the content.
