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In the ever-evolving realm of investments, mutual funds have witnessed a substantial surge in popularity among those seeking to diversify their portfolios and optimize their financial returns. Mutual funds serve as a collective investment vehicle, pooling resources from a multitude of investors who share a common financial goal.
These funds are professionally managed and diversified across various asset classes, enhancing investors’ diversification. The corpus is managed by a fund house, overseen by managers who strategically invest across different instruments, such as equities, government securities, and corporate bonds, aligning with the scheme’s investment objective and the risk profile.
Within mutual funds, investors can opt for two distinct types: direct or regular plans, each tailored to specific investor preferences and goals.
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Direct mutual funds are investment schemes which the fund house or asset management company (AMC) provides directly to investors. Investors can purchase these funds directly without involving intermediaries like brokers, distributors, or financial advisors. It eliminates the need to pay commissions or distribution fees to third-party intermediaries, resulting in a lower expense ratio than regular plans.
Expense ratio is the fee charged for managing and operating the fund. Investors can access direct plans through the fund’s website or by visiting the fund house in person.
In contrast, regular mutual funds are procured through intermediaries like brokers, financial advisors, or distributors. These intermediaries offer various services, including investment advice, portfolio evaluation, and transaction assistance.
In this scenario, the fund house pays the intermediary a commission or distribution fee, slightly elevating the expense ratio for regular mutual funds compared to direct mutual funds. The commission has an effect on the investors’ overall returns because the fund house pass on these charges to the investor which impacts the overall gains.
The funds have significant differences, including the expense ratio, commission structure, capital appreciation, and target investors. The expense ratio represents a mutual fund’s annual fees and operating costs. The absence of broker or advisor commissions in direct mutual funds translates to a lower expense ratio.
For example, in the case of a direct mutual fund with an expense ratio of 0.5%, only 0.5% of the AUM is used to cover expenses. On the other hand, commissions paid to advisors increase the expense ratio in regular mutual funds. For instance, a regular fund might have a slightly higher expense ratio of approximately 1%, meaning that 1% of the AUM is allocated to cover various expenses, including advisor commissions.
Net asset value (NAV) is a critical metric in mutual funds, representing the per-unit market value of the fund’s securities. It’s calculated by dividing the total fund assets by the number of units outstanding. Direct mutual funds typically have a higher NAV due to their lower expense ratio. This lower expense ratio in direct funds allows a larger portion of your investment to actively generate returns, potentially leading to higher overall returns compared to regular funds with higher expense ratios.
For example, if an investor puts INR 1 lakh in both direct and regular mutual funds with an average market return of 12.5%, the direct fund could yield a 12% return, while the regular fund might offer an 11% return, ultimately accumulating a larger corpus when it comes to direct mutual funds.
With direct funds investors themselves have to take complete control over their investment decisions, keeping track of investments, asset allocation, and portfolio management which can be a time-consuming task. They are also responsible for conducting market research, understanding fund strategies, and making investment decisions independently.
On the other hand, investing through an intermediary in regular mutual funds comes with additional services like maintaining investment records, helping investors with the investment process (documentation), providing tax proofs, and offering personalized services and advice. These added services enhance convenience, making regular mutual funds attractive to investors seeking comprehensive support and assistance.
For example, a new investor might opt for a regular mutual fund to benefit from a financial advisor’s guidance and expertise in navigating the complexities of the market.
Though choosing direct mutual funds may save on fees, it can also mean less access to advice, technology, efficient processes, and a clear financial plan which will be provided by the intermediary.
The Securities and Exchange Board of India (SEBI) regulates direct and regular mutual funds and offers the same level of protection. The distinction lies in the expense ratio and the level of guidance and advice received, which can impact potential returns.
The decision between direct and regular mutual funds holds significant weight, as it directly impacts your investment journey and financial outcomes. To make the right choice, it’s crucial to grasp the differences in expense ratios, commissions, and overall returns.
If you’re well-versed in the world of investments and have a deep understanding of the market, regular mutual funds may not provide substantial additional benefits. In such cases, investors can choose from direct mutual funds, where they have full control and potentially higher returns due to lower expenses.
However, if you’re new to the world of investing, regular mutual funds through financial intermediaries can be a prudent choice. The intermediary plays a pivotal role by providing continuous monitoring and making necessary portfolio adjustments to enhance your investment returns.
While there might be a nominal convenience fee associated with this service, it’s a small price to pay for the substantial benefits in terms of service quality and improved returns that regular mutual funds provide.
