Most Indians associate expensive goods with better-quality products. This notion generally holds water. However, in the case of investment products, especially mutual funds, more often than not, this notion is completely incorrect. Since childhood, it has been inculcated in our minds that costlier goods and services cost more than their cheaper counterparts because they offer a superior product. For example, in the case of purchasing a car costing more would represent a car that is more durable and has better features than the one that is cheaper.
As adults, when we encounter investment products such as mutual funds, we instinctively associate investment products charging us a higher fee as superior products. Consumers assume that in exchange for higher investment costs, they will be provided with higher returns. Given the low level of financial literacy in India, hardly an investor undertakes research or looks for empirical evidence before making an investment. Very often investors blindly follow the advice of their parents, friends, or broker in selecting their mutual fund investments.
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Two Key Differences
Let's understand and analyze the two major differences between purchasing a manufactured good such as a car and purchasing a mutual fund.
● Future Promise: In the case of purchasing a car you can elect to purchase a premium product by paying a premium price. Cars are tangible products and you can upfront check out different cars at different price points. Essentially, you can test and decide upfront whether a premium category car justifies its price or not. In the case of purchasing a mutual fund, consumers will not get the entire product upfront, i.e., the returns associated with mutual funds are available only at a future date. In case of all investment products including mutual funds the consumer at the time of purchase is essentially purchasing future returns.
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● No Guarantee: In the case of market linked investment products there is no guarantee in terms of returns which will be generated in future. In case of purchasing a car, you have a warranty on your hands assuring you problem-free performance for a definitive period.
Expense Ratio And Direct And Regular Mutual Fund Investments
Most investors are unaware that, typically, each mutual fund scheme has two versions of it: direct and regular. The regular version of the mutual fund is distributed through brokers or agents. The direct mutual fund scheme is distributed directly through means such as the website of the mutual fund. We recommend using Kuvera’s - India’s first 100% free platform for zero-commission mutual fund investments.
Apart from distribution, another major difference between regular mutual fund schemes and direct mutual fund schemes is the difference in expense ratio. Mutual funds charge investors an annual fee called expense ratio. The expense ratio essentially is the cost which an investor pays to the mutual fund for managing investments on behalf of the investors who have purchased the mutual fund units. A regular mutual fund scheme has a higher expense ratio than the direct version of the same mutual fund scheme. The reason behind the variance in expense ratio between the two versions is linked to the difference in distribution between the two versions. The regular scheme has a higher expense ratio since the commission of the mutual fund distributor is in-built in the expense ratio. As mentioned above, in the case of a direct schemes, the distribution of the mutual fund scheme is undertaken through zero-commission channels.
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Conclusion
Investing in a regular scheme just because it has a higher expense ration would be detrimental for your financial health. Mutual fund which are charging you more in form of expense ratio are often regular scheme of mutual funds. For investors, the premium investment cost does not guarantee a superior product for the investors. Individuals purchasing regular schemes are, in essence, buying the same investment product as those who are buying the direct scheme of the mutual fund but at a higher cost. Earlier, it was difficult to purchase the direct schemes of mutual funds. One was required to visit the office of the mutual fund house to invest in direct schemes. However, all that has now changed with digital investment platforms like Kuvera , which allow you to invest in direct schemes of mutual funds digitally. All you need is your smartphone.
