Direct vs regular mutual fund: Which one should you invest in?

For investors in mutual funds, one of the crucial decisions is choosing between a direct plan and a regular plan. This decision can significantly impact returns over the long term, as both options have distinct advantages and disadvantages that suit different types of investors. In this guide, we'll break down the difference between direct vs regular mutual funds, covering the key characteristics, pros and cons, impact on returns, and tax implications of each option. By the end, you'll be equipped with the information needed to choose the investment type that best aligns with your financial goals and preferences.

What are direct mutual funds?

Direct mutual funds are investment plans in which investors buy units directly from the mutual fund company, bypassing intermediaries. This structure removes the costs associated with commissions or broker fees, leading to lower expense ratios and, consequently, higher potential returns for the investor. Direct mutual funds are accessible through mutual fund companies' websites or digital platforms, making it easy for tech-savvy and DIY investors to manage their investments.

Key points

• Lower cost structure: By eliminating middlemen and commission fees, direct mutual funds have lower expense ratios.
  
• DIY approach: Investors need to research and manage their investments independently.
  
• Higher returns potential: Savings on commissions enhance compounding over time, benefiting long-term investors.

While the percentage difference in expense ratios may seem small, the effect on returns can be substantial over the years, especially for investors with larger portfolios.

What are regular mutual funds?

These are bought through intermediaries such as brokers, agents, or financial advisors. These intermediaries provide investment guidance , helping investors choose suitable funds based on their risk tolerance , goals, and financial plans. However, this convenience and advice come at a cost: commissions, included in the expense ratio. As a result, regular plans generally have higher expense ratios than direct plans, which can reduce long-term returns.

Key points

• Increased expense ratio: Includes commission fees for brokers or advisors, making regular plans costlier.
  
• Guided investment option: Advisors provide advice, support, and monitoring, making regular funds suitable for new or hands-off investors.
  
• Convenience: Advisors often handle paperwork and other logistics, which can simplify the investment process.

Regular plans may benefit beginners or investors who prefer a guided approach, allowing them to navigate complex investment decisions with professional help.

Also read : Is it worth switching from regular to direct funds?

Direct vs regular mutual funds

Understanding the fundamental differences between direct and regular mutual funds is essential in making an informed choice.

• Expense ratio: Direct mutual funds have a lower expense ratio because there are no intermediary costs, while regular funds include distribution commissions. This difference in expense ratios directly impacts returns, especially in the long term.
  
• Returns: Due to lower expense ratios, direct mutual funds often yield higher returns than their regular counterparts. For long-term investors, even a minor difference in returns can have a substantial impact through compounding .
  
• Investment pathways: Direct mutual funds are typically purchased online, whereas regular funds are bought through brokers or advisors. Direct plans may appeal more to tech-savvy or DIY investors, while regular plans suit those who prefer guidance.
  
• Investor knowledge level: Direct mutual funds are better suited for experienced investors who can independently research funds. Regular funds, on the other hand, provide professional support, which may be beneficial for new investors.

Pros and cons of direct and regular mutual funds

Both have their advantages and drawbacks, depending on the investor's experience, goals, and preferences.

Pros of direct mutual funds

• Lower costs: With no intermediary fees, direct mutual funds generally have a lower expense ratio.
  
• Higher returns Potential: Lower expenses increase compounding effects, particularly beneficial for long-term investors.
  
• Control: Direct investments give investors complete control over their portfolios, from fund selection to transaction execution.

Cons of direct mutual funds

• Requires knowledge: Direct plans require a strong understanding of fund selection and investment research.
  
• No advisory support: The lack of professional advice may be a disadvantage for those who need guidance.

Pros of regular mutual funds

• Guidance and support: Advisors provide fund recommendations, risk assessment, and market insights, which can be especially helpful for beginners.
  
• Convenience: Investors receive help with paperwork and administration, making regular funds easier to manage.

Cons of regular mutual funds

• Higher expense ratios: Commissions make regular plans costlier, which may reduce returns over time.
  
• Less control: Investors rely on advisors for fund selection and portfolio management, which limits direct involvement.

How does each plan impact long-term returns?

For long-term investors, the choice between direct and regular plans can significantly affect compounded returns. A lower expense ratio in direct mutual funds leads to a compounding advantage, especially over a decade or more. Even a 1 per cent difference in annual returns can result in thousands of rupees saved or earned, depending on the portfolio size.

Consider a hypothetical example:

• Monthly investment: Rs 10,000 in a direct plan vs a regular plan of the same fund for 15 years.
  
• Assumed return: 12 per cent per annum
  
• Expense ratio: 0.5 per cent for direct vs 1.5 per cent for regular.
  
• Estimated investment value after 15 years: Rs 47.6 lakh for direct vs Rs 43.7 lakh for regular.
  
• After 15 years, the compounded difference is substantial, favouring the direct plan due to cost savings.

This impact is especially relevant for investors with larger portfolios and longer time horizons, as they stand to gain more from the lower expenses in direct plans.

What are the tax implications of direct and regular mutual funds?

When it comes to taxes, both have identical tax treatments . Both types of funds follow the same rules for capital gains tax, based on the holding period.

Key tax points

• Equity funds: Short-term capital gains (STCG) tax applies if held for less than one year, while long-term capital gains (LTCG) tax applies for periods beyond one year.
  
• Debt funds: All gains are taxed at the investors' income tax slab rate, regardless of the holding period.
  
• Tax benefits of higher returns in direct plans: While tax treatment remains the same, direct mutual funds' higher returns can lead to a greater wealth accumulation and thus a higher taxable amount. However, this is usually offset by the advantage of greater wealth creation.

Which mutual fund type should you choose?

Ultimately, choosing between the two comes down to your experience level, need for guidance, and financial goals .

• Direct mutual funds: Ideal for experienced, hands-on investors comfortable with researching and managing their investments. Direct plans offer long-term benefits through lower costs, which can be a significant advantage in compounding returns.
  
• Regular mutual funds: Suitable for new investors or those who prefer the support of an advisor. Regular funds provide the convenience of expert guidance and are often recommended for those less familiar with fund selection.

Also read : Common sense about risk

Conclusion: Build wealth wisely with the right mutual fund choice

Investing in the right type of mutual fund can make a significant difference over time, especially for long-term investors. By understanding the differences between direct and regular mutual funds, their costs, and the potential impact on returns, you can make an informed decision that aligns with your financial aspirations. Remember, while direct plans provide cost-saving advantages, regular plans offer guidance that can benefit those new to investing.

Ready to choose the best mutual fund for your needs? Explore our mutual fund screener tool to compare direct and regular options, and subscribe to our newsletters for more insights on making smarter financial choices.

You might also like : Things to know before switching from a regular to a direct mutual fund plan