Most of the mutual fund has four options of investment: two dividend-based and two investment medium mode based. When we were talking about dividend-based mutual fund type, we discussed about the importance of investment medium for mutual funds. If you are a long term investor like us, you would be amazed at the impact it has on your wealth accumulation. Two-investment medium mode based are “Direct fund” and “Regular fund” .
Before we can get into the specifics, you need to understand about TER. For running a mutual fund successfully, there will be an operating expense. SEBI allows AMCs to pass on this to the investors in the form of “Total Expense Ratio” This percentage is levied on the investor on daily basis.
So for example, if TER is 1.5%, it means that deduction happens every day from your corpus at the rate of 1.5% per annum. You pay TER for the expertise and structure that the mutual fund house has put in place. In plain words, this is the percentage of operating expense to the overall asset on an annual basis. Okay, why is this important for you to know? Because this is the key differentiator between the two types of mutual fund.
Types of Mutual Funds:
Regular Mutual Funds: In regular Plan, Mutual Fund Company pays the intermediary hidden percentage of commission every quarter. This commission comes out of your investments. How? In addition, that is why definition of TER was important! As you saw the TER, operating expense include the commissions paid to the intermediary. Therefore, regular funds will have a higher TER compared to the direct mutual funds.
Direct Mutual Funds: This is where you directly approach the AMC fund house via website or their registered offices. As you might have already guessed, the TER is lower. Again, as per the definition of the TER, the operating expense of the fund decreases and hence the TER is lower than the “Regular” counter parts by a percent or percent and half.
Comparing the Returns:
You may be wondering, what good a meager 1.0 – 1.5% is going to be. You might actually be amazed to see under the hood. Assuming that you invest ₹1 lakh each in a Direct and Regular Mutual fund. Even if the TER of the direct plan is 1% and that of the regular plan is 2.5%. Compounding at 12%, the returns earned by both the plans over 40 years, the investment trend would be as follows:
As you can see from the above image, over long run, the return for a same investment is significantly higher in direct plan compared to a regular plan. So, now you know how important investment medium is to your investment journey. Of course, do review all your mutual funds with proper diligence prior investing.