Crucial features about direct option that young investors need to be aware of

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All mutual fund investment schemes have 2 different options – direct and regular options. Fund features of both options like investment strategies, fund management, benchmark indices, asset allocation strategy, portfolio composition, etc., stay the same. However, direct options have an edge over regular plans in terms of expense ratio, returns and net asset value (NAV).

Here are some important features about direct plans, which all investors should know to make an informed decision when investing in a mutual fund.

Lower expense ratio

Expense ratio of a mutual fund shows a percentage of its net assets (daily) used for meeting its operating expenses (annual). Operating expenses usually include fund administration expenses, sales & agent commissions, advisory fees, investment management cost, distribution expenses, and market costs. While regular plans are sold via brokers or advisors in lieu of a commission, direct plans are sold directly to investors by the AMCs or through MF online platforms without the need to pay distributor commission. Thus, direct plan’s operating expenses are generally up to 1 percent lower than regular options, which translates to reduced expense ratio for direct plans.

Higher returns

Lower expense ratio on direct plan results in higher returns. As the savings in distribution expenditures stay invested in direct options, such savings themselves start to generate returns owing to the effect of compounding. While in the starting phase such differences may appear marginal, it becomes huge over the long run. For example, if you invest Rs. 10,000 in a regular plan of a mutual fund via SIP for 30 years at 13% annualized returns with a 2% expense ratio, the corpus will be Rs. 2.51 crore. On the other hand, if the same amount of Rs. 10,000 is invested via SIP in a direct option of the same mutual fund with expense ratio of 1%, the corpus will grow to Rs. 3.15 crore over the same time horizon. Difference in the corpus will be Rs. 64.28 lakh with direct option outperforming the regular option by 20%.

Higher NAV (Net Asset Value)

NAV of the direct option is higher as compared to the regular plan due to their higher returns. Given the operating expenses of the fund is subtracted from their AUM, a lower expense ratio of their direct option results in higher NAVs. Additionally, owing to the compounding effect, the difference in both plans’ NAV becomes bigger.

Where can you buy direct plans?  

You can purchase the direct plan from mutual fund houses or via their respective RTA (Registrar and Transfer Agent), either through physical application or online mode. However, note that such processes can be unhandy and complicated because you need to separately apply with every fund house, which leads to paperwork duplication and formation of several passwords.

Instead, you can invest in mutual funds in India through direct options via financial advisors in exchange of an advisory fees. Such fees are directly paid to the independent advisors and it does not get lowered from your NAV. Another cost effective and simpler mode is to approach online financial markets, which permits you to invest in direct options of mutual funds via a single podium without having to pay any annual maintenance or advisory charges.