Savings on direct mutual funds, does it really matter?


I was looking at expense ratio of DSP Tax saver, regular is at 2.51 and direct is 1.27. Does this difference really matter? Should I invest in direct or regular?


It does matter and quite a bit. Let me tell you why.

The world around us is changing very fast. A recent survey predicts that Fixed Deposit rates in India will drop to 4.5% by 2020, gold prices haven’t gone anywhere, real estate cyclically has maybe gotten into a phase of no absolute % returns. Though this might all seem like me convincing you to invest in the markets, this is not about that. :slight_smile:

The point I am trying to make is, as a country, we are getting into a phase of much lower % return on investment across all asset classes. So maybe 5.5% from FD next 5 years vs over 10% historically. Maybe 10% from stock markets vs 15% historically. So any optimization in choice of investment that can add even few basis points to your ROI can create significant difference.

So maybe opting for debt mutual funds which are almost exactly like FDs but give say 1% higher returns. Banks take your money and lend it to others, Debt mutual funds take your money and lend it to corporates. Even though both are doing the same, Mutual funds are operationally much lighter (no branches, relationship managers, etc), hence can give higher yields.

Similarly Direct mutual funds instead of regular, where expense ratio is on an average 1% lesser across equity funds. This would mean you making 1% extra on your investment every year. This is actually more than 1% per year because this 1/365% is debited daily from NAV, if market moves up, this will be higher than 1%. Btw if you don’t know how to pick the right MF, pay a fixed fee to an advisor to help you select.

This 1% difference might seem small, but in a lower % ROI cycle that we are currently in, this is 10 to 20% extra every year. What I am trying to say is when MFs are returning 15% annually - 1% extra is 6% lesser on your return. If MF start returning 8% annually, this 1% now means 13% lesser in returns if invested in regular funds.
Compound this for 10 years, the savings made can be ridiculous. A Rs 5000 SIP monthly in direct mutual fund at end of 25 years can mean upto Rs 28lks more money vs investing in regular mutual fund (assuming 1% extra as expense and CAGR of 15%).

So yeah need to be smart about your money. Unless you hit a jackpot in life, all these small optimizations is what can eventually help create the additional delta.


But if we are investing in small amounts of few Lakhs, paying 50rs/month fee and the expense ratio would work out to be more or less same isn’t it?


Even with a few lakhs it would matter. Expense ratio is paid every year. So if you are paying 1.2% more (like in DSP case) for regular, then it would mean 1.2%(daily compounded) more every year.