Only the cost structure in the direct and regular mutual fund schemes differ from each other. From the fund manager to a portfolio, everything else is the same.
Before we get into more details, you need to know the cost of mutual fund investment and how it affects your returns.
When you invest in a mutual fund plan, the fund house charges you an annual fee for managing your money. The yearly charge, known as the Expense ratio, includes all expenses, including the fund’s management fees and operating expenses.
The expense ratio is a percentage of the total assets of the fund and is subtracted from the returns generated. Therefore, an investor will always benefit from a mutual fund scheme / or a scheme with a low expense ratio, as the mutual fund company will take less money from the returns generated.
A direct plan of a mutual fund scheme is a cheaper option as compared to a regular scheme.
When you invest in a mutual fund through a regular plan, there is an embedded commission that is paid annually to your agent or broker until it remains invested. That essentially translates to a higher ratio of costs and, therefore, lower returns for you.
On the other hand, if you purchase a direct plan from the fund house either on their website or in their office or can goes through a registered investment advisor (RIA) like online. Since you are going straight, there is no dealer involved, so there is no fee to pay, which means a lower expense ratio.
Although the difference between direct and regular mutual fund schemes expense ratios can be around 1 percent, it can make a big difference to your overall corpus.
Let us take an illustration to understand it better.
For example, through a monthly SIP of Rs 6000, Mr. X and Mr. Y invested in a mutual fund scheme. While Mr. X chooses the regular plan of the scheme, Mr. Y has invested in direct plans.
Mr. X, who invested in the regular scheme, received Rs. 1.20 crores, while Mr. Y received, 25 years later, Rs. 1.45 crore. There is a difference of more than 25 lakhs.
Because there is no fee involved, direct plans are better than regular plans. What are the commissions? Okay, you have to understand how this works for mutual funds.
Next, there are fund houses that build mutual funds, raise money, invest that money, and eventually increase the funds. Then the dealers (probably) go door-to-door and bringing consumers to these Fund houses. Hence the money that fund houses and distributors receive is called the investment ratio and is deducted from the fund’s AUM.
Now, when direct plans are implemented, the distributor departs. And that’s why the fund’s expense ratio goes down because the fund house does not have to pay distributors’ commissions.
And since the expense ratio of the direct plan is low, you get the difference in the form of higher returns. Simple Mathematics. Whether it is a bull run or bear hug in the market, it is assumed that direct plans will give you more profits.