I still get queries from readers asking that does it actually make sense to switch their mutual fund investments from regular plans to direct plans.
The simple answer is Yes.
And I also tell them that since direct plans of mutual funds have been in existence for several years (since 2013 to be exact), they are already late!
But jokes apart, let’s put some doubts to rest first.
Here are 3 important facts about Direct plans vs Regular plans:
- Returns of direct plans will always be higher than regular plans of the same fund/scheme. That is, direct plans will always outperform the regular ones.
- The NAV of Direct plan will always be higher than that of Regular plan of the same fund/scheme
- Since the Direct-NAV is higher than Regular-NAV, you will get lesser no. of units for direct plans for the same amount invested. But still, your returns will be higher than those of regular plans.
There should be no doubt about these 3 things.
Under direct plans of the mutual fund schemes, you invest directly with the mutual fund house (AMC). And since there is no intermediary or distributor involved in between, the commissions are saved. And this reflects in the lower expense ratio of the direct plans – which in turn, reflects in better returns as compared to the regular plans. All else remains the same. The fund manager, the portfolio of stocks, everything remains the same.
Now let’s see how the returns of direct plans have fared since when they came into being (in early-2013).
I have chosen the Large-Cap Funds category (from SEBI-specified mutual fund categories) and taken the few popular and big funds as an example (and not as fund recommendations) here.
As you will see below, the Direct Plan of any chosen fund has given higher returns (or lower losses) in each year of existence when compared with the regular version:
And Direct Plans of MF giving Higher returns than Regular plans will continue to remain so in future as well as the expenses of direct plans will always be lower than the regular plans.
Lets now look at the NAVs of one (randomly chosen) fund to see how NAV changes over the years.
I chose HDFC Equity Fund as an example. As you can see below, the gap between the NAV of Direct Plan and Regular plans is increasing every year. And since the direct plan will give a higher return than regular plan every year, this gap will continue to increase further with each passing year:
Some people feel (and after being intentionally confused by regular-plan sellers like MF distributors, agents, banks which always sell regular plans) that Direct Plans are expensive than regular plans – after all, NAV of direct is higher.
But this is a wrong way of thinking. And the opposite is true.
No doubt, NAV of direct plans is and will always be higher than regular plans. But that is not because it’s expensive but because direct plans have a lower expense ratio which allows its NAV to grow faster. Hence, NAVs of direct plans are high and will continue to grow faster than regular plans.
You will get fewer units when you buy direct plans. But it comes with a faster-growing NAV. And this will give you better returns.
Let’s take 2 simple examples of why this is true and why direct plans can create more wealth than regular plans.
What would be the value of Rs 10 lac investment made one-time on 1st January 2013 in HDFC Equity Fund’s Direct Plan and Regular plans separately?
Here is the answer:
As you can see, the value of investment made in direct plans is higher by almost 5% after just 6 years.
Now that was about lumpsum investment. But what about a Rs 25,000 monthly SIP in both Direct and Regular Plan of the same MF scheme?
Below is shown the value of the SIP between Jan-2013 and Jan-2019. The SIP is done monthly but data is shown only 6-monthly for making it concise:
Even though you got a lesser number of units in direct plans, you still ended up with a larger corpus at the end. And this is why the argument of you-get-lesser-units-in-direct-plan-so-its-expensive doesn’t stand.
Direct plans will give smaller no. of units but also (more importantly) give better returns than the regular plans.
By the way, if you feel that this % difference isn’t big, then remember that when you are investing in mutual funds, you are investing for the long term – like 10, 20 years or more (like in retirement).
And when that happens, this small difference every year builds up into a much larger difference. Because of compounding – which with each passing year, will grow and grow and convert this small percentage difference into a large absolute difference which you would not be able to ignore then after several years.
With that said, be reminded that Direct mutual funds will always (I repeat ALWAYS) outperform their regular plans of the same mutual fund scheme.
And despite their higher NAV, the Direct plans of Mutual Funds offer better returns than Regular plans.
If you are an investor who doesn’t want to lose out on these additional returns which are available for direct plan investors ‘only’, then you should switch to direct plans as soon as possible. But remember, it only makes sense for you to get into direct plans when you either know which mutual funds are good for you and your goals OR you are getting proper advice by a trustworthy and competent investment advisor.