Direct vs regular mutual funds: Why the same scheme can give different returns

When you open a mutual fund scheme on an investment app, you will often come across an important choice: Direct Plan or Regular Plan?

At first glance, both options may appear identical. The fund manager, investment strategy and portfolio of stocks, bonds or other assets are generally the same. Yet, their Net Asset Values (NAVs) and the returns earned by investors can differ.

Both plans invest in the same underlying assets. The main difference lies in how the investor purchases the fund and the costs involved in the process.

A regular plan is usually purchased through an intermediary such as a mutual fund distributor, bank, broker or financial advisor. The intermediary may help investors choose suitable schemes, complete investments and provide other related services.

In return, the Asset Management Company (AMC) pays a commission to the distributor for acquiring and servicing investors. This commission is included in the scheme's expenses, which is why regular plans generally have a higher expense ratio than direct plans.

A direct plan enables investors to purchase mutual fund units directly from the AMC without involving a distributor or other intermediary.

Since there is no distributor commission, the expense ratio of a direct plan is generally lower.

Over the long term, this lower cost can translate into marginally better returns, assuming the direct and regular versions of the scheme continue to invest in the same portfolio.

The expense ratio represents the annual cost charged by a mutual fund to manage investors' money. In a regular plan, a portion of this cost is used to pay distributor commissions. A direct plan does not carry this distribution expense, resulting in a lower overall expense ratio.

The difference can often range from around 0.5% to 1% or even more annually, depending on the type of mutual fund.

While this may appear insignificant, the impact can become substantial over time because investment returns compound. Even a difference of 0.75% annually can potentially add up to lakhs of rupees over 10 or 20 years for a reasonably large investment portfolio.

The difference in NAVs is among the most common sources of confusion for mutual fund investors.

Although direct and regular plans invest in the same underlying portfolio, their NAVs generally differ because their expenses are not the same. The lower distribution-related costs of a direct plan result in a different expense structure, which can lead to a different NAV and return performance.

In both cases, investors are participating in the same investment strategy. The key difference is essentially the cost of accessing that strategy.