What are Direct Mutual Funds?
Let’s say you want to buy an apple. You decide to head out to your nearest supermarket to buy an apple. Here, the supermarket is the middleman between you and the farmer. If you could buy an apple directly from the farmer by eliminating the middleman, you would be saving the commission (or mark up) that you would have to pay the supermarket.
This is exactly how Direct Mutual Funds work. A Direct mutual fund allows you to buy mutual funds directly from the AMC or fund house without using a distributor as an intermediary. You save on huge commissions by investing in Direct mutual funds.
Let’s break down a few terms from the explanation.
What is a fund house?
A fund house, also known as an Asset Management Company is an establishment that invests a pool of funds (which are called mutual funds) from various investors into a variety of financial instruments like Stocks, Bonds, Government Securities, and so on. A few examples of fund houses are DSP Mutual Fund, SBI Mutual Fund, Nippon India Mutual Fund, etc. There are about 41 Asset Management Companies in India.
Who is a distributor?
A Mutual Fund distributor is a person or an organization that facilitates the mutual fund transaction between the investor and the AMC. Think of the distributor as the agent in between. The commissions paid out by AMC are the incomes for the distributor. The commissions are paid by taking a small percentage from the funds you invest.
For example, if you invest Rs.1000 in a fund via a distributor, the AMC pulls out Rs.10/- from your funds and pays the distributor. So your starting investment is Rs.990/- and not Rs.1000/-.
However, if you choose to buy a mutual fund via the direct mode, there is no distributor involved, hence there is no commission paid out, and therefore you will start your investment with Rs.1000/-.
As a result, the returns that you generate by investing in a direct fund will be higher compared to the regular fund counterpart.
To dig deeper into Direct Funds, it is important to understand the role of NAV. More on this here.