Direct mutual funds vs regular plans: Do lower fees really mean higher returns?

Direct mutual funds allow investors to invest directly with the fund house or through an investment platform, without a distributor or commission. Introduced in 2013, direct plans have a lower expense ratio than regular plans. However, lower costs do not automatically translate into better investor outcomes. Direct plans now account for 30% of assets under management (AUM) among individual investors.

The average diversified equity fund's direct plan has an annualised expense ratio of around 1.12%, compared with 2.07% for the regular plan.
Over 10 years, a monthly SIP in the average equity fund generated:
● Direct plan: 15.93% annualised return
● Regular plan: 14.78% annualised return
For a Rs 10,000 monthly SIP, the direct plan generated around Rs 27.42 lakh, compared with Rs 25.58 lakh in the regular plan over 10 years. That is a shortfall of Rs 2.03 lakh in the regular plan, pocketed by the distributor. As the investing time horizon expands, this chasm widens.

The lower expense ratio assumes that investors remain disciplined and stay invested through market cycles. In reality, investors may:
● Chase recent winners and investment fads
● Panic and redeem during market falls
● Stop SIPs when returns disappoint
● Restart investments based on market movements
● Switch funds at the wrong time
The fund may perform well while the investor's timing and behaviour may hurt returns.

Experts say the hidden cost of poor investment decisions can outweigh the visible savings from a lower expense ratio. Ajay Kumar Yadav, Group CEO & CIO, Wise Finserv, points to poor asset allocation, wrong fund selection, panic exits, stopped SIPs and mistimed switches as potential behavioural costs.

Regular plans have the same fund and fund manager but incur a higher expense ratio due to distributor or intermediary costs. The additional cost can provide access to professional guidance and behavioural support. A competent adviser or distributor can help investors manage emotions, asset allocation and decisions during volatile markets.

The additional cost is justified only when the adviser or distributor provides continuous and meaningful value.

Investors do not necessarily have to choose between low-cost direct plans and professional advice. SEBI-Registered Investment Advisers (RIAs) are required to recommend direct plans because they charge an advisory fee rather than earning commissions on products they sell. This allows investors to combine the lower cost of direct plans with professional guidance, provided they are willing to pay the adviser's fee separately.

Direct plans can make sense for investors who:
● Understand markets and valuations
● Can assess risk beyond returns
● Have the discipline to remain invested
● Can manage asset allocation independently
● Can control emotions during market volatility
For such investors, paying the higher embedded cost of a regular plan may not be necessary. But for investors who need ongoing guidance and behavioural discipline, the additional cost of a good adviser may provide meaningful value.