Direct vs Regular Mutual Funds : What banks won’t tell you
I. Introduction
Mutual funds are an investment vehicle where multiple investors pool their money together to be managed by financial professionals. These professionals invest in a diverse mix of assets, like stocks and bonds, aiming for high returns leading to growth in wealth over time.
Understanding different types of mutual funds is significant for a variety of reasons:
Not all mutual funds are created equal, and the type you choose—either direct or regular—can significantly impact your financial outcomes. Understanding these differences is critical to avoid being misled by hidden costs and conflicted advice that could reduce your returns.
II. Direct Mutual Funds
Direct mutual funds are the no-nonsense option. When you buy these funds, you’re purchasing directly from the mutual fund company, without involving any intermediaries. This straightforward approach means you don’t pay any commissions, keeping your investment costs low.
You can purchase direct mutual funds easily through the fund company’s website or an authorised app. Without a middleman, you have full control over your investments and don’t have to worry about hidden commissions cutting into your returns.
Advantages
Lower costs: No commissions mean a significantly lower expense ratio, putting more of your money to work.
Higher returns: Over time, the savings from lower fees lead to higher returns, allowing your wealth to grow faster.
Transparency: You have a clear understanding of where your money is going, with no unnecessary layers between you and your investments.
Potential drawbacks
More responsibility: You need to make informed choices about which fund to invest in, which requires some financial knowledge, though technology makes these choices easier.
Risk of mistakes: Without professional guidance, there’s a risk of making poor investment decisions, though this risk is often overstated.
III. Regular Mutual Funds
Regular mutual funds, on the other hand, come with a hidden cost that many investors overlook: the commission fees paid to intermediaries like banks, brokers, and mutual fund distributors posing as financial advisors. These commissions are baked into the expense ratio, making regular funds more expensive than direct.
Regular mutual funds are sold through intermediaries who earn commissions by recommending these funds to you. While they may provide advice and handle the paperwork, these intermediaries are often more interested in their commissions than in your financial well-being. Further, they continue to collect daily commissions for the entire time you have an investment in the fund!
Advantages
Convenience: The only real advantage of regular mutual funds is the convenience of having someone else help with the investing process for you. But this comes at a steep price.
Potential drawbacks
Higher costs: The commissions paid to intermediaries result in higher expense ratios, which directly eat into your returns. Over time, these costs significantly reduce your wealth.
Conflicted advice: Financial advisors and banks may push funds that pay them the highest commissions, rather than those that are best for your investment goals. This conflict of interest can lead to suboptimal investment choices that benefit them more than you.
Lower long-term returns: The higher costs associated with regular mutual funds compound over time, leading to noticeably lower returns compared to direct funds. What seems like a small difference in fees can translate into lakhs—or even crores—of lost returns over the long term.
IV. Case: Tata Digital India Fund
If you invest ₹10,000 per month into Tata Digital India Fund via a Systematic Investment Plan (SIP) for 30 years, here’s how your investment results would differ between Direct and Regular Plans:
Direct Plan: Your investment would grow to ₹129 crore over 30 years. A direct plan avoids brokerage or financial adviser fees since there’s no middleman. This keeps all your investments within the fund, resulting in higher returns.
Regular Plan: In contrast, the regular plan would grow to ₹76 crore. While this is a substantial sum, it’s significantly lower because a portion of your returns goes toward commission fees over time.
The Difference: In a regular plan, ₹53.6 crore would be paid in commissions over 30 years—a massive amount that could have been part of your investment returns. The key takeaway is that direct plans provide a major advantage by lowering fees, ultimately leading to greater long-term wealth.
IV. Direct vs Regular Funds - Key differences
Expense ratio
Direct mutual funds have a significantly lower expense ratio because they cut out the middleman. Regular funds, with their embedded commissions, charge you more for the same underlying investments, leading to unnecessary costs.
Returns
Because direct funds have lower fees, they generate higher net returns. Regular mutual funds, with their higher expense ratios, consistently deliver lower returns, robbing you of potential gains.
Distribution channel
Direct mutual funds are purchased directly from the mutual fund company, while regular funds are sold through intermediaries like banks or other distribution channels. This difference in how they’re distributed has a direct impact on costs—and ultimately, on your returns.
Professional guidance
Regular mutual funds are often marketed as providing valuable professional advice. However, this advice is frequently compromised by the intermediary’s desire to earn commissions. In contrast, with direct funds, you avoid the conflict of interest altogether, although you may need to do more of the research in choosing the fund to invest in yourself.
V. Buying Mutual Fund through Banks
A major source of revenue for banks is in the form of commissions from the sale of regular mutual funds to bank customers. In FY 2023-24, SBI Mutual Funds (AMC) paid out a total of INR 2,024 Crores in commissions to distributors. Of that, State Bank of India alone accounted for more than 50% of the total payout, earning INR 1,039 crores from selling regular mutual funds to their customers.
You might think buying a mutual fund of your bank through your bank wouldn’t entail any commissions. But the truth is, they earn substantial commissions from these products, which may incentivize them to prioritize their profits over your financial health.
As a result, investors may unknowingly pay higher fees, eroding their long-term returns and jeopardizing their financial goals.
VI. Direct vs Regular Mutual Funds
Factors to consider
Your investment knowledge: If you’re willing to educate yourself or do some research, direct funds are almost always the better choice.
Cost sensitivity: Investors who care about maximizing their returns and minimizing unnecessary expenses should steer clear of regular funds.
Investor profile suitability: Direct mutual funds are ideal for savvy investors who want to keep costs low and returns high. Regular mutual funds might seem appealing to those looking for guidance, but the reality is that this guidance often comes at an unjustifiable cost. Unless you are completely unwilling to manage your investments, direct funds are the smarter choice.
VII. Conclusion
Regular mutual funds are a poor choice for most investors. They come with higher costs, conflicted advice, and lower long-term returns. Direct mutual funds, on the other hand, offer a more cost-effective way to invest, with the potential for significantly higher returns due to their lower expense ratios.
Don’t let banks and intermediaries dictate your financial future. The choice between direct and regular mutual funds is more than just a financial decision—it’s a choice between putting your money to work for you or allowing it to be siphoned off by unnecessary fees and commissions. Educate yourself, ask the hard questions, and make the choice that truly benefits you in the long run. Direct mutual funds are the smarter, more efficient way to build your wealth and secure your financial future.