Do you know that direct plans of mutual funds offer much higher returns than regular plans, more than the difference in their expense ratio?
To know better, read it till the end.
Every mutual fund scheme has two plans to offer – Regular & Direct.
Both plans have the same fund manager and the same portfolio. The only difference is the expense ratio. Ideally, the difference in the expense ratio of the direct and regular plans should be the difference in the returns of the two schemes. Interestingly, this is not the case.
Regular plans have two sets of expenses – Expenses charged by mutual fund companies for their management fees and another expense charged by mutual fund companies to pay to the distributor on a regular monthly payout.
Direct plans have only one expense – fund management fees and no deduction to pay to the distributor.
Regular plans are sold by distributors/agents who receive commissions of up to 1.75%/annum (on a monthly payout basis), till your investments are outstanding.
Direct plans are recommended by SEBI Registered Investment Advisers (RIAs). As per the SEBI regulations, RIAs can only recommend zero-commission investment options wherever available (mutual funds, PMS & AIFs). Direct plans can be purchased directly from mutual funds/RTA websites/apps or through third-party platforms.
SEBI mandated that the difference between the expense ratio of direct plans and regular plans should be equal to the commissions paid to the distributors/agents. This is reflected in the returns. For example, if a regular plan of a mutual fund scheme A delivers 10% returns, a direct plan of the same scheme A will give 11.5% returns, a difference of 1.50%/annum.
On closer examination, we found that the difference in returns between direct plans and regular plans is higher than the commissions paid to the distributors/agents.
Check the table below for reference. Consider the selected schemes as samples from a broader universe.
One reason for this variance is the compounding benefit of direct plans over regular plans. Since the expense charged to a mutual fund is daily, the compounding benefits direct plans due to lower expenses.
Therefore, instead of looking at the differences in the expense ratios, you must look at the differences in returns between direct plans and regular plans for your investment decision-making. Ultimately, what matters to you as an investor are the returns.
Originally posted on LinkedIn: www.linkedin.com/sumitduseja
Truemind Capital is a SEBI Registered Investment Management & Personal Finance Advisory platform. You can write to us at connect@truemindcapital.com or call us at 9999505324.
