Regular and direct mutual fund plans invest in the same underlying securities with the same investment objective and fund manager. The key difference is that the fund in a regular plan is managed by agents or fund advisors, while in direct plans, the fund is managed directly by the investor.
This also makes the expense ratio of regular plans higher than that of direct plans as agents charge commission of around 0.5% to 1.5%, which is paid by the investor. This difference may appear small, but even a gap of around 1% can have a major impact on returns over a long investment horizon.
However, the higher is not the only drawback investors should be aware of when choosing between regular and direct mutual fund plans. Here’s what else investors need to know.
Potential conflict of interest
In regular plans, there is the possibility of conflict of interest because the distributor is also compensated by the product manufacturer, said Harendra Zatakia, a Sebi RIA and the founder of Wealth Aligned Financial Advisory.
However, that does not mean the recommendation is necessarily wrong or unsuitable. The investor should understand the economic incentive and how the intermediary is compensated, he added.
Zatakia advised investors to ask two simple questions before opting for a regular mutual fund plan: “Who is paying for the advice I am receiving and is this fund the best solution for my objective, or simply the product being recommended?”
This essentially means that the objective should not be to assume that commission-based advice is wrong, but to ensure that product selection is driven by suitability rather than compensation.
How much more does a regular plan cost?
The primary drawback of regular plans is the higher ongoing cost, which continues for as long as the investment remains in the mutual fund plan and compounds over time. An expense ratio is the annual fee charged by a mutual fund to manage an investor’s money and cover operational costs which is expressed as a percentage of the individual’s total investment.
The benefit, on the other hand, is the service provided by a distributor, which includes help with scheme selection, transactions, documentation, operational support and ongoing handholding. For a first-time or less experienced investor, that convenience can have real value, the expert noted.
To understand the extra costs involved when opting over a regular mutual fund plan over a direct one, let’s consider a ₹25 lakh investment earning a hypothetical gross return of 12% a year:
- Direct plan: Illustrative expense ratio of 0.75% → net return of 11.25%
- Regular plan: Illustrative expense ratio of 1.75% → net return of 10.25%
| Horizon | Direct plan | Regular plan | Difference |
|---|---|---|---|
| 5 years | ₹42.60 lakh | ₹40.72 lakh | ₹1.88 lakh |
| 10 years | ₹72.60 lakh | ₹66.33 lakh | ₹6.27 lakh |
| 15 years | ₹1.24 crore | ₹1.08 crore | ₹15.71 lakh |
| 20 years | ₹2.11 crore | ₹1.76 crore | ₹34.83 lakh |
Over 20 years, the difference is approximately ₹34.8 lakh under these assumptions, which can be a substantial amount. However, this is an illustration and not a return forecast, Zatakia said.
Should you switch from regular to direct plans?
Direct plans do not necessarily mean going entirely DIY, as investors can engage a Sebi-registered investment adviser for financial planning. Existing regular-plan investors, however, should not switch blindly just to lower costs. They should first consider their portfolio, tax implications and any transition costs.
According to Zatakia, investors should consider the following factors before switching mutual fund plans:
- Capital gains tax that may arise on redemption
- Exit loads and lock-ins, including applicable restrictions
- Suitability and quality of the existing funds
- Difference in expense ratio and the resulting long-term benefit
- Whether the transition should be done immediately or in phases
“Switching is a portfolio decision, not merely a transaction. The objective should be to move to the right portfolio at the right cost while avoiding unnecessary tax and transaction costs,” he added.