Direct vs Regular Mutual Funds : What banks won’t tell you
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.
Mutual funds in India began in 1963 with the establishment of Unit Trust of India (UTI), initiated by the Government of India to offer investment options to retail investors. In the 1990s, private sector mutual funds were introduced, broadening investor choices. The sector grew with the creation of the Securities and Exchange Board of India (SEBI), ensuring regulation.
In 2000, the Association of Mutual Funds in India (AMFI) was formed to promote ethical standards. Till 2013, investors had only one way of investing in mutual funds, through intermediaries such as financial advisors, brokers, and distributors. These intermediaries played a crucial role in reaching retail investors, offering guidance and helping them choose suitable schemes.
As financial literacy improved and online platforms evolved, more investors sought control over their investments without relying on middlemen. This trend towards direct investing created a market shift that SEBI recognized and formalized through regulatory changes. So in January 2013, Direct mutual funds were introduced by SEBI allowing investors to bypass intermediaries and invest directly with fund houses (asset management companies), reducing costs and increasing returns for investors.
By removing intermediaries, investors avoid commission fees, thus lowering the expense ratio of the funds and improving overall returns. So today, investors have two choices:
Regular - to go through an intermediary
Direct - To invest directly with the AMC and save the commissions paid to intermediaries
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.
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.
Direct vs Regular Funds - Key differences
The key differences between a regular plan and direct plan investment are explained in the table below::
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.
As we can see above, an investor would lose Rs. 54.80 crore by investing in a regular plan. The difference in returns due to compounding can be significant. The power of compounding is a fundamental concept in investing where returns earned on an investment generate additional returns over time, leading to exponential growth of wealth. This effect becomes particularly pronounced over long investment horizons.
Regular plans include embedded commissions for intermediaries that reduce the effective returns on investment. In contrast, direct plans, which bypass intermediaries and associated commission costs, offer lower expense ratios. Over time, the reduced costs in direct plans lead to more of the returns being reinvested, thereby enhancing the compounding effect and potentially resulting in substantially higher returns compared to regular plans. This difference highlights the importance of evaluating costs when planning for long-term investments.
Buying Mutual Fund through Banks
Banks serve as intermediaries in the distribution of mutual funds, using their large networks and customer relationships to promote and sell fund schemes. While they offer convenience and a variety of investment options, banks primarily act in their own interest by earning commissions from mutual fund companies., which could impact overall returns, making direct mutual fund plans a more cost-effective option.
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 Rs. 2,024 crore in commissions to intermediaries. Of that, Rs. 1,039 crore was paid to State Bank of India alone for selling regular mutual funds to their customers.
While you might think buying a mutual fund of your bank through your bank wouldn’t entail any commissions, the truth is, banks earn substantial commissions from these products, which may incentivize them to prioritize their profits over your financial health.
This can create a conflict of interest, as their recommendations may be driven by the potential for earning commissions rather than what is best for the you. As intermediaries, banks add an extra layer of cost for investors, and any mutual funds bought through banks are regular schemes and not direct schemes. Below is a table of commissions paid by the AMCs of banking companies to the banks as their intermediaries:
How do you buy Direct Mutual Funds?
To invest in mutual funds, customers have to be KYC compliant. KYC (Know Your Customer) is a mandatory one-time process which SEBI mandates to maintain transparency and safeguard the financial system. It can be done physically or online through fund houses, online platforms, or authorized entities like CAMS and KFintech. Investors must provide identity and address proof, such as PAN and Aadhaar, along with other personal details. KYC helps verify the investor's identity and prevents fraud, money laundering, and other illegal activities.
There are several ways to buy direct mutual funds in India:
Fund House Websites: Investors can visit the official website of a mutual fund house (e.g., SBI Mutual Fund, HDFC Mutual Fund) and directly invest in their schemes by creating an account, completing the KYC process, and choosing the "Direct Plan" option.
Mutual Fund Apps: Many fund houses offer mobile apps for easy access to direct mutual fund investments. These apps allow investors to browse, select, and invest in schemes on the go. Some of these are MFU online
Registrar and Transfer Agents (RTAs): Platforms like CAMS and KFintech allow investors to buy direct mutual funds across different fund houses in one place. Investors can complete their KYC and manage their portfolio conveniently.
Investment Platforms: Online platforms like Groww, Kuvera, Paytm Money, and Zerodha Coin offer direct mutual fund options. These platforms provide easy navigation, comparisons, and the ability to invest in funds from various companies without intermediary commissions. However, such online portals are run by private firms that offer robo-advisory financial planning services, usually for a fee – which could be per year or per transaction.
AMFI’s MF Utility Portal: The Association of Mutual Funds in India (AMFI) provides a unified platform where investors can buy direct mutual funds from multiple fund houses in one place.
By using any of these methods, you can avoid intermediary commissions, leading to cost savings and potentially higher returns over time.
Choosing between Direct vs Regular Mutual Funds
Factors to consider
Your investment knowledge: If you’re willing to educate yourself and doing your own research, direct funds are the better choice, offering better value.
Cost sensitivity: For those aiming to maximize returns and minimize costs, regular funds—with their higher fees due to commissions—should be avoided.
Investor profile suitability: Direct mutual funds are ideal for 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 comes at an unjustifiable cost. Unless you are completely unwilling to manage your investments, direct funds are the smarter choice.
Conclusion
For most investors, regular mutual funds are not an optimal choice. They come with higher costs, conflicted advice, and lower long-term returns. Direct mutual funds, with their lower expense ratios, provide a more cost-effective way to invest, offering the potential for better returns.
Do not allow banks and intermediaries to dictate your financial decisions. The choice between direct and regular mutual funds goes beyond financial considerations—it is about determining whether you want your money to work for you or be diminished 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 a smarter, more efficient path to building wealth and securing your financial future. Educate yourself, ask the right questions, and choose wisely.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.