Understanding Expense Ratios: Direct vs. Regular Mutual Fund Plans

Back in 2012, SEBI had come out with several reforms which included the introduction of direct plans in mutual funds.

Starting from January 1, 2013, every mutual fund in India comes in two variants – a Regular Plan and Direct Plan. Both versions are the exact same scheme, run by the same fund managers investing in the same stocks and bonds.

So, the question is, which plan is better for you: direct or regular plan?

Lets look into these two variants in detail.

Difference between regular and direct plan

Here are the 5 key differences between these two variants of mutual funds.

1. Definition

Direct plan funds are those mutual funds where the asset management company (AMC) or mutual fund companies do not charge distributor expenses, trail fees, and transaction charges.

Regular plan funds are traditionally mutual funds that have been sold through brokers and intermediaries.

The commission that they earn by selling mutual funds is added to the expense ratio of the fund.

2. Difference in expense ratio

Direct plan funds have expense ratios which are much lower as compared to regular plan funds.

Have a look at the difference in the expense ratio of some popular mutual funds in two variants.

Fund Name Expense Ratio – Regular Plan (%) Expense Ratio – Direct Plan (%) HDFC Small Cap Fund 2.14% 0.54% SBI Bluechip Fund 2.35% 1.18% L&T Low Duration Fund 1.03% 0.56% Indiabulls Liquid Fund 0.17% 0.07%

*The expense ratio is as observed on 18th September 2018.

You can clearly see the difference in expense ratios of both variants. This will result  in a BIG difference in returns, in the future.

3. Difference in Net Asset Value (NAV)

Due to the difference in expense ratio, the resulting NAV of the same fund’s direct plan will be much higher.

And the gap between the NAV of a regular and direct plan will only increase with time.

Let’s have a look at the regular and direct NAVs of the same mutual funds mentioned in the previous table.

Fund Name NAV – Regular Plan (INR) NAV – Direct Plan (INR) HDFC Small Cap Fund 45.49 48.3 SBI Bluechip Fund 38.76 40.83 L&T Short Term Income Fund 19.13 19.47 Indiabulls Liquid Fund 1746.28 1755.98

*the above NAV is as observed on 18th September 2018.

You can clearly see the NAV of the direct version of the same mutual fund is always higher. The older the fund, the higher the difference in NAV.

4. Difference in returns

Direct plan funds fetch you higher returns as compared to regular plan funds.

This difference can be substantial over long investment periods. The average difference in expense ratio between direct and regular plan is 0.66%.

While this number may not seem like a lot but this amount gets paid every year and with the power of compounding can balloon into a huge number over the years.

Let me show you a few examples

Here’s a comparison between the returns from direct and regular plans of 3 mutual funds.

For simplicity, I have taken an initial investment amount of ₹ 10,00,000 (lump sum) in all examples.

1. SBI Bluechip Fund

Direct Regular Difference Initial investment amount ₹10,00,000 ₹10,00,000 0 Investment tenure 5 years 5 years 0 Avg. 5 Year Return 20.42% 19.27% 1.15% Final return amount ₹25,23,771.53 ₹24,10,515 ₹1,13,256.53

As seen from the above table, there is a difference of ₹1,13,256.53 between returns from the direct and regular plan of this fund, with an initial investment amount of ₹10,00,000 for 5 years.

2. HDFC Small Cap Fund

Direct Regular Difference Initial investment amount ₹10,00,000 ₹10,00,000 0 Investment tenure 5 years 5 years 0 Avg. 5 Year Return 27.11% 25.79 % 1.32% Final return amount ₹33,18,169.71 ₹31,49,420.04 ₹1,68,749.67

As seen from the above table, there is a difference of ₹1,68,749.67 between returns from direct and regular plan of this fund,. The initial investment amount is taken as ₹10,00,000 for 5 years.

3. L&T Midcap Fund

  Direct Regular Difference Initial investment amount ₹10,00,000 ₹10,00,000 0 Investment tenure 5 years 5 years 0 Avg. 5 Year Return  31.99% 30.92% 1.07% Final return amount ₹40,05,946.5 ₹38,46,183.35 ₹1,59,763.15

As seen from the above table, there is a difference of ₹1,59,763.15 between returns from the direct and regular plan of this fund. The initial investment amount is taken as ₹10,00,000 for 5 years.

5. Professional advice

Professional financial advice is important and it can make a big difference to your returns. Mutual fund advisers can help you understand and manage your mutual funds more effectively.

However, it is not necessary that you depend on a mutual fund adviser. If you can do your own research and understand mutual funds well enough, you can invest in direct mutual funds thus avoiding the services of a mutual fund adviser.

You could also hire an independent mutual fund adviser to advise you also.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww