The expense ratio is a significant factor to consider when investing in mutual funds. It influences your overall returns, as a lower expense ratio means more of your money is working for you. But why is there a difference in the expense ratio between direct and regular mutual funds? Let us explore this distinction and how it impacts you while investing in mutual funds.

The expense ratio is a term that points to how much an investment company has to charge each year in order to manage a mutual fund. To put it simply, it is considered as a percentage of assets held by such funds, and it encompasses operating costs that may range from administrative and advertising costs to other management costs, among others.

In other words, the expense ratio is the percentage of your investment amount to cover the operational costs of the fund. You can calculate it by dividing the sum of the total operating expenses by the average value of the fund's assets. This amount is subtracted from your net returns, so you get a better net return when the expense ratio is low.

You may also use a mutual fund calculator to better understand possible returns.

• The expense ratio is the yearly fee collected by mutual funds for managing investments, and directly impacts your returns.
• Direct mutual funds have the benefit of being a low expense ratio, because they do not accrue any charges for intermediary commission.
• Regular mutual funds have higher expense ratios, mainly because of the associated agent or advisor commissions.
• Even a very small difference in the expense ratio leads to wide variations in returns over time.

The expense ratio typically has a number of components, such as:

• Management fee: Fees paid by the manager running the fund to undertake its investments.
• Administrative costs: These contribute towards the day-to-day running of the fund, including accounting, record-keeping, and customer services.
• Distribution and marketing fees: These are also known as 12b-1 fees, and are paid for advertising and promotional activities.

SEBI made several critical amendments that reshaped the mutual funds market:

1. Direct plans were introduced as an alternative to regular plans.
2. Fund houses were allowed to charge a lower expense ratio for direct plans.

These changes resulted in lower costs for investors opting for direct plans, as they eliminated the need for intermediary commissions.

Also read: What Is Systematic Withdrawal Plan (SWP)

The difference between direct and regular mutual fund schemes lies in the involvement of the intermediaries. These are agents or, in some cases, advisors who manage the fund. It involves more expenses. However, a direct plan allows you to invest directly with the fund house, and therefore avoid the intermediaries involved.

The cost ratio, thus, is lower for a direct plan as there are no agent commissions. Even though the difference may sound quite minimal in the expense ratio, it can potentially cause a major difference in your returns over time.

Let us look at the key distinctions:

The regular plans pay commissions to the agents or advisor. It varies from 0.5% to 1.5%. That is what you, an investor, end up paying. In case of direct plans, such costs do not exist, hence the expense ratio remains minimal.

For someone investing in mutual funds for the first time or who is not willing to take on the responsibility of managing investments directly, regular plans are useful at higher costs. Where you already have experience and have the knowledge and confidence to run your investments, direct mutual funds may be cheaper and yield higher returns over the long term.

The Bajaj Finserv Mutual Fund Platform has an user-friendly interface and has over 1,000 mutual funds for you to choose from. The platform additionally provides robust tools that would help you compare mutual funds, so that you can choose an option that is best suited for you.