Do more mutual fund units translate to higher returns?
Recently, a Zerodha Varsity reader came up with an interesting question about direct vs. regular mutual funds. He understands that the return on a direct fund is higher, so buying a direct fund makes sense. But he also feels that one can accumulate more mutual fund units in a regular fund, given that the NAV is lower. So, would the more units of a regular fund offset the higher NAV of a direct fund?
For people who are unaware, regular plans are bought through intermediaries and have higher expense ratios due to the commission costs involved. On the other hand, direct plans do not have this commission component, resulting in lower costs. This cost difference ranges from 0.5% to 1%, which is why a direct plan’s NAV is higher than a regular plan’s NAV of the same scheme.
Given this, let’s take some numbers and check if accumulating more units increases the overall wealth created.
Going back five years, assume you have Rs.10,000 to invest in June 2019. You have two options: buy ICICI Pru Blue Chip Fund’s direct plan at Rs 46.1 per unit, which will yield 217 units, or buy the regular plan at a lower NAV cost of Rs 43.5 per unit, which will yield about 229 units.
Clearly, the number of units in a regular fund is higher than that of a direct fund.
Over the next five years, the NAV of ICICI pru Bluechip’s direct plan grew to Rs 103.62 per unit, while the regular plan moved to just Rs 94.96.
Multiplying the current NAV by the number of units, investment in the regular plan would now be worth Rs 21,819, which is lower than the Rs 22,491 of the direct plan.
If you see in the chart above, the direct plan’s NAV grew at a compounded growth rate of 17.6% CAGR compared to the regular plan’s growth at a lower 16.9%. The difference is because of the regular plan’s higher expense ratio, which caused the corpus to grow at a slower rate.
This illustrates that the higher number of units in the regular plan at the time of purchase does not offset the returns generated by the growth of direct funds’ NAV.
Please note that the ICICI Pru BlueChip Fund is used solely as an example and is not a recommendation.
Side note: Just because a direct plan comes with lower costs and generates higher returns doesn’t mean it’s the right choice for everyone. If you don’t understand investing or where to invest, seeking help from an intermediary with your financial goals is important.
