What are Direct Mutual Funds and How Do They Work?

The mutual fund industry in India has picked up pace as people find a range of funds to suit their growing investment needs, including cost-effective options for investors. In terms of affordability and higher returns, a direct mutual fund may be considered by investors. Direct mutual fund schemes are appealing as low-cost options, with low expense ratios. This is because direct mutual funds can be invested directly with the mutual fund house/the asset management company (AMC), without involving brokers or other intermediaries like distributors. Hence, lower costs are associated with these funds, encouraging investors to choose them. Knowing the characteristics of direct mutual funds is paramount if you wish to add these to your portfolio for successful investment.  

What are direct mutual funds?

A direct fund or direct mutual fund is a distinctive kind of mutual fund scheme that permits investors to directly buy units of a mutual fund from the asset management company or the fund house. Essentially, this means that no agents, distributors, brokers, or other intermediaries are engaged when an investor invests. Directly purchased from the source, investors interact with the mutual fund house or the AMC themselves.  

The main distinctive feature of these funds is that, since there is no intermediary involved in investment, there is no distribution fee or commission involved. Thus, direct mutual fund investment is seen as a cost-effective manner to invest in mutual funds relative to investing in regular mutual funds. From the investor’s standpoint, they may interact with the AMC or fund house directly through their websites. This permits investors to have greater control and transparency in their investments. Such an approach, direct in its nature, offers investors low costs and higher returns.  

How do direct mutual funds work?

In a mutual fund which is a direct plan, anyone investing in this is required to directly invest with the fund house or AMC in question. There is no intermediary like a distributor, agent, or broker to assist in the process. On the other hand, in a regular mutual fund investment, intermediaries like bankers, brokers, or distributors facilitate the transaction of starting a mutual fund investment. This typically entails a distribution fee which is deducted from the said mutual fund scheme.  

Key Features of Direct Mutual Funds 

A direct mutual fund has some key features, highlighted below:  

Low Expense Ratio & Cost-Effectiveness: The expense ratio in a direct plan is lower than that of a regular mutual fund plan. The reason is that, in a direct plan, there is no commission or distribution fee involved. Thus, commissions and distribution fees, typically borne by investors, do not have to be paid, making this economically viable.  

Investment Options Available Online and Offline: Investors can invest in direct plans through online or offline channels. Online avenues are popular and investors can buy mutual fund units via different investment portals and Registrar & Transfer Agents, resulting in convenient and smooth transactions.  

Advantages of Investing in Direct Mutual Funds 

Direct mutual fund investment offers several benefits to investors and these are listed below:  

High Returns/Low Expenses: A direct mutual fund scheme is characterised by a relatively low expense ratio, and hence, offers potentially higher returns than other regular mutual fund schemes. This becomes particularly clear when mutual fund units are held for lengthy periods.  

Higher NAV: The NAV or Net Asset Value of a mutual fund is critical. The NAV is calculated by dividing the portfolio assets’ total value by the number of outstanding mutual fund units. Direct mutual fund schemes are prone to have a higher NAV than regular plans as there is no commission or brokerage fee involved.  

Types of Direct Mutual Funds

Here’s a glimpse of the types of schemes on offer in the category of “Direct Mutual Fund”:  

Stock Mutual Funds-Direct Plan: These mutual funds allocate your money to a diverse mutual fund that invests majorly in equities. The aim for investors is growth here.

Bond Mutual Funds-Direct Plan: These mutual fund schemes let you buy diverse mutual fund units of bonds, aiming to give you a steady income.  

Money Market Mutual Funds-Direct Plan: Money market direct mutual funds invest your capital in short-term debt securities, aiming for a steady NAV or net asset value.

Balanced Mutual Funds-Direct Plan: In a direct mutual fund constituting a balanced mutual fund plan, you can invest your money in a combination of equity, bonds, and other assets, achieving a balanced mutual fund portfolio.  

Index Mutual Funds-Direct Plan: Index mutual funds invest their capital in a basket of securities that track the performance of a certain index of the market.

Speciality Mutual Funds-Direct Plan: Speciality mutual funds, as the name suggests, invest your wealth in particular industries or sectors, for instance, healthcare, consumer goods, or technology.  

How to Invest in Direct Mutual Funds 

Once you know the answer to the question, “What are direct mutual funds?”, you may want the answer to another question as to how to invest in direct mutual funds. You can do so by following a few simple steps:

Step 1: Research direct plans online and find some that are aligned with your risk profile and investment strategy.  

Step 2: Visit the online platform of any mutual fund house or AMC offering you a direct plan you have chosen and go through an online KYC process. Alternatively, you can physically visit the fund house and apply with a physical application there.  

Step 3: Once you have selected the plan and the number of units you wish to invest, you can apply for it and you will receive an intimation from the mutual fund house.  

Taxation on Direct Mutual Funds 

There are certain tax implications if you invest in a direct mutual fund. The guidelines related to taxation for direct mutual funds are the following:

The tax on any capital gains made from mutual funds tends to vary based on the type of fund invested in and the fund’s duration (period of holding).  

Mutual funds that invest 65% or above in equities or equity-linked securities are classified as equity-based funds for the purpose of taxation. The remainder of the funds is categorised into debt-based securities.

Direct mutual fund investment that yields short-term capital gains is liable for short-term capital gains taxation at a flat 15% on equity funds. Long-term capital gains tax is pegged at 10% but there is no long-term capital gains tax levied on returns of ₹1,00,000 in a fiscal year.  

In terms of debt funds, taxation of capital gains is applied based on the applicable tax slab of the investor. The gains are added to the taxable income of the investor.  

Conclusion 

Grasping elements of direct mutual funds is the key to sound investment in this often-chosen category of mutual fund investment. With direct mutual funds, you get the perks of low-cost investment along with transparency, two attractive variables for any investor today. Direct mutual fund investment enhances an investor’s financial portfolio by potentially higher returns and low expense ratios that do not take a bite out of mutual fund potential returns. When investors embrace the proficiency of direct mutual funds, they make tactical moves and gain an edge over their investment, potentially leading to positive outcomes.