Direct Plan or Regular Plan: Understanding The Pros And Cons

Are you puzzled about whether to select a direct plan or a regular plan when investing in mutual funds? Read the report to gain a proper understanding with Rakesh Deshmukh taking a closer look at the scenario

Last week, my friend and I were discussing our investment portfolios when he noticed that I had invested in some direct mutual plans, while his portfolio consisted of regular plans. Surprised, he asked me, “Aren’t they essentially the same thing?” My friend had always thought they were just two similar ways to invest in mutual funds. He asked, “What sets them apart?” I explained to him that while direct and regular plans may seem similar at first glance, they actually have some significant differences. Considering you are planning a vacation, when you go to a travel agent, he will not only book the hotel for your chosen destination but also suggest whether you should go by road, train or air, recommend places worth seeing, and so on, thus helping you out with a complete roadmap.

Similarly, in regular plans, there is the involvement of a middleman. In this case, financial advisors or distributors assist you in selecting the right mutual funds and managing your investment portfolio. In the direct plan, you collect information, whether from your mentors or from a personal financial planner, and select the direct plan, avoiding assistance from distributors and financial advisors. In this category, you interact directly with the AMCs to invest in funds.

Direct funds are those mutual fund schemes that are directly offered by the fund house or AMC. The word ‘direct’ indicates that there is no involvement of a third party, distributor or agent. The investors directly deal with the AMC offering the fund. On the other hand, regular funds are those mutual fund schemes that are sold through agents and distributors. Since investors don’t deal directly with the fund house, there are commissions or brokerage charges involved in regular funds. However, investors don’t pay the commission directly to the agent.

It’s obvious that if someone is offering you extra services, even if they are initially free of cost, there must be hidden costs involved. The same principle applies here as well. Before delving deeper, it’s important to understand the TER (total expense ratio). It represents the fee charged to investors by the mutual fund company for the recurring operating expenses associated with servicing them. TER is charged proportionately against the assets of the scheme and adjusted in the price or the net asset value (NAV) of the unit.

TER includes management fees, registrar’s fees, trustee fees, marketing costs and distribution costs. Distribution cost is the commission paid to the mutual fund distributors or financial advisors who are intermediaries between the AMC and the investor. It is one of the most important criteria to compare a direct plan with a regular plan. Let’s delve into the key distinctions between direct and regular mutual fund plans:
1. Impact on Net Asset Value (NAV) — The total expense ratio plays a crucial role in adjusting the NAV of mutual fund schemes. Since the TERs of regular plans are higher than those of direct plans, the NAVs of direct plans naturally stand higher. In simpler terms, for the same investment amount, your NAV will be higher in a direct plan compared to a regular plan.
2. Impact on Returns — The difference in TER between regular and direct plans varies depending on the commission structure of AMCs. For instance, if the TER of a regular plan is 0.75 per cent higher than that of a direct plan, the direct plan would yield 1 per cent higher CAGR returns. Over a long-term investment horizon, this variance in returns can accumulate into a substantial difference.
3. Role of Financial Advisor — Direct plans cater to do-it-yourself (DIY) investors who prefer managing their investments independently. With the advent of online investment platforms and mobile apps, investing in direct plans has become more accessible. However, financial advisors play a crucial role in assisting investors with investment decisions, portfolio monitoring and providing personalised guidance.

What Does the Data Say?
In my previous organisation, my manager always used to say, “I only believe in god. For the rest of the things, provide me the data.” Jokes aside, let’s analyse what the data says. Does it truly make sense to choose one over the other, or are they essentially the same with not much difference? Of course, we invest our money to earn returns from the invested capital. So, we need to analyse the return part using data. For the analysis, we will compare the average returns of direct plan and regular plan of various schemes across different categories, such as Large-Cap, Mid-Cap, Small-Cap, multi-cap, thematic or sectoral funds, and others, across different time periods to gain insights into the reality of the situation.

Based on the data provided, none of the categories over the specified time period showed lower returns in the direct fund plan compared to the regular plan. However, there were two instances where the returns were nearly identical. Another interesting finding from the data is that when funds generated negative returns, the direct funds experienced the smallest decline compared to the regular funds. This means that not only do direct plans offer higher returns but also experience less of a drop when the market declines or the fund underperforms and yields negative returns. Does such a small difference truly impact your portfolio with only a small variance in returns, with the highest difference being around 1.97 per cent or 2 per cent? Considering this, let’s identify the best performing multi-cap fund where we find the highest disparity in the return between both the direct and regular plans over the past year.

As discussed earlier, we can observe the difference in profit and returns percentages. While this is for only one year, over a longer duration, such as 10-15 years, these small differences can accumulate significantly over time, especially when compounding magic works. Let’s examine the contrast over a span of 10 years.

Additionally, it’s worth highlighting that both the returns from the Kotak Multi-Cap Fund and the NAVs of both the plans were different. One NAV was at Rs 16.674, while the other was at Rs 16.109. With this information, you can likely determine which NAV corresponds to which plan. When considering the expense ratio, the regular plan boasts a 1.7 per cent, while the category average is 2 per cent – significantly higher than 0.42 per cent for the direct plan, where the category average is 0.72 per cent. Other factors such as fund managers, inception date and benchmark indices remain the same for both plans. To reiterate, if you are receiving any services, they likely come with a cost attached.

Conclusion
Direct plans offer lower costs and potentially higher returns compared to regular plans, making them an attractive option for savvy investors. However, investing in direct plans requires a certain level of investment experience and knowledge. Investors must be prepared to dedicate time to monitoring their investments and take appropriate actions as needed. On the other hand, for investors seeking expert guidance and assistance, regular plans provide the support of financial advisors. Understanding the pros and cons of both these options is essential for investors to choose the plan that aligns best with their financial objectives and preferences. In essence, whether to opt for a direct or regular mutual fund plan depends on individual investment experience, preferences, and the level of involvement desired in managing one’s portfolio.