Markets have corrected, it’s the best time to Invest in mutual funds

Effective from January 2013, as per the mandate of the Securities and Exchange Board of India (SEBI), the fund houses or asset management companies (AMCs) have classified mutual funds into two categories, and they are regular funds and direct funds.

A direct mutual fund is a scheme that investors directly purchase from the fund house or asset management company (AMC). There is no third party, agent, or distributor involved between the investors and fund houses.

A regular mutual fund is sold through a third party, agent, or distributor. The AMC pays a commission or brokerage to the agent when they manage to find investors. Therefore, the expense ratio of regular funds would be higher when compared to direct funds.

However, the asset allocation, investment objective, and the fund manager(s) would be the same for regular and direct funds.

Here are the four major advantages of investing in direct funds:

    1.Low Expense Ratio

    As there is no third party involved between the investors and fund houses, the expense ratio of direct funds would be lower than that of regular funds. In regular funds, the AMCs pay the agents a commission for their services, and they recover this through expense ratio. Though the difference in the expense ratio between regular and direct funds might seem minimal, over time, the difference would grow to a significant sum.

    The Net Asset Value (NAV) of a mutual fund is the ratio of the value of the total assets in its portfolio to the number of outstanding units.
    NAV = (Value of the assets owned)/(outstanding units)
    The assets owned by a mutual fund can be equity shares of various companies, debt instruments such as bonds and treasury bills, and cash instruments.
    As there are no brokerage charges imposed on the investors in case of direct funds, the NAV of direct funds would be higher than that of regular funds.

    3.High Returns

    Since there is no brokerage or commission involved in direct funds, the expense ratio of direct funds would be lower than that of regular funds. Although the difference in the returns between the regular and direct funds might not look significant, it would be massive when you invest with a long-term horizon. Here’s an example:
    Consider investing Rs 15,000 a month in SIP for ten years in both regular and direct plans of a fund house. Let’s assume that the returns offered by the direct and regular funds are 12% and 11% respectively. For regular funds, the AMC pays a commission of 1% to the agent. The following table shows the amount accumulated at the time of redemption:

     

    Parameter

    Direct Fund

    Regular Fund

    Difference

    Monthly SIP amount

    Rs 15,000

    Rs 15,000

    0

    Investment Tenure

    10 years

    10 years

    0

    Returns 

    12%

    11%

    1%

    Amount accumulated at the time of redemption

    Rs 34.51 lakh

    Rs 32.55 lakh

    Rs 1.96 lakh

    4. No Conflict of Interest

    Since you are directly dealing with the fund house, you don’t run a risk of being misled by an agent or a distributor. There are chances of agents or distributors luring you to invest in particular schemes for their benefits. Thus, by choosing to invest in direct funds, you rule out the conflict of interest scenario.

After knowing the advantages of investing in direct funds over regular funds, it’s only wise to invest in direct funds. You can save on paying unnecessary commissions and keep the expense ratio on the lower side. Also, you would get higher returns on direct funds when compared to that of regular funds.

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