Direct Mutual Funds Return - Fewer Units but Better Return

Most of us have already begun investing in mutual funds because it is an excellent way to steadily create wealth over a long term. However, when choosing funds to invest in, we always come across two versions of the same mutual fund. One, that is termed as ‘regular’ and the other that is called ‘direct’. What is the difference between the two? Let us find out.

A regular mutual fund is a mutual fund scheme where a third party, usually a broker or agent is involved. As an investor, you do not deal directly with the fund house offering the mutual fund. You approach them via a third party. Naturally, this third party charges a fee or commission that comes out of your investment.

A direct mutual fund is a mutual fund scheme where you directly invest in a particular mutual fund scheme by dealing with the fund house without having a third party in between. Since there is no broker involved, you’re not charged any commission and your overall returns tend to be higher.

Lower Expense Ratio

The first reason as to why direct plans give higher returns is the expense ratio, which is simply the expenses incurred by the AMC in managing the fund. Since there are no agents involved, the commission aspect can be totally avoided in a direct plan. And hence the expense ratio will be lower. Your returns over the long run will be significantly higher.Since the returns of a direct plan are higher, the NAV is also higher than a regular plan.But shouldn’t you be investing in plans that have lower NAV as opposed to a higher one?Absolutely not.A regular plan has a lower NAV than a direct plan but still the direct plan is the better investment option. Let us explain how.Let’s assume that you invested Rs. 10 lac each in a direct and a regular plan of the same mutual fund. The NAV of the regular plan is Rs. 90, giving you 11,111.11 units, whereas the NAV of the direct plan is Rs. 100, giving you 10,000 units.Judging only by the number of units, you’dfeel that the regular plan is better because you got more units for the same investment. But there is more to it than that.Let us assume a return of 20% on the regular plan and a return of 20.75% on the direct plan. (We can safely assume a slightly higher return for the direct plan because the expense ratio is lower, and the money saved here will be added to your returns.)After a year, the NAV of the regular plan will increase to Rs. 108 (20% increase on Rs. 90 NAV). The NAV of the direct plan will increase to Rs. 120.75 (20.75% increase on Rs. 100 NAV)So, after a year your original investment will stand at Rs. 12,00,000 for the regular plan and Rs. 12,07,500 for the direct plan.This clearly shows that the Direct Plan, despite giving lower units, will give higher returns.

Thus, it is clearly evident that a direct mutual fund scheme will give you higher returns than a regular plan. Even though the higher NAV will result in lesser units for your investment, you can rest assured that the eventual returns will be much higher. As the differences in NAV for both plans keep on increasing, the direct mutual fund return will also increase significantly!

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.