Small cap mutual funds are known for their potential to deliver high returns — but with equally high risk. Choosing between direct and regular plans for these funds is more than just a paperwork decision; it can shape how much you potentially earn from those investments.
This article unpacks the key differences between direct and regular small cap fund plans, how expense ratios affect outcomes, and why understanding these structures is important to aligning your investment approach with long-term wealth-building goals.
Table of contents
What is direct plan in small cap funds?
In a direct plan, an individual invests with the asset management company (AMC) online or offline without the help of a distributor. It was introduced by SEBI to give investors the option of do-it-yourself investing. Since there is no intermediary involved, the expense ratio under the direct plan is usually lower, as the AMC does not need to pay a commission to compensate for the distributor’s services. Everything else – scheme objective, portfolio composition, fund manager – remains the same as the regular plan.
What are regular small cap funds?
Regular plans route your investment through a mutual fund distributor, who earns a commission—known as a trail fee—that is factored into the fund’s total expense ratio (TER). This fee compensates intermediaries for services such as investment guidance and administrative support. However, because it adds to the TER, the overall cost of investing in a regular plan tends to be slightly higher than a direct plan
As a result, net returns from regular plans are usually marginally lower, since a portion of the gross returns is used to cover these distribution expenses. This difference is only due to the expense ratio – the gross portfolio returns are the same for both plans.
Key differences between direct and regular plans
| Feature |
Direct plan |
Regular plan |
|---|
| Purchase route |
Investor ↔ AMC |
Investor ↔ Distributor ↔ AMC |
| TER components |
Management fee + admin costs + miscellaneous |
Management fee + admin + distribution fee + miscellaneous |
| TER |
Relatively lower |
Relatively higher |
| Potential long run return impact |
Typically slightly higher as a lower TER is deducted from gross returns |
Typically lower due to higher TER. |
| Suitability |
Cost-conscious investors who prefer planning and managing their own portfolio. |
New investors or those who prefer a distributor’s assistance for scheme-selection, transactions and portfolio tracking. |
Expense ratio: An important factor in returns
To ensure fairness and transparency in costs, SEBI prescribes limits on TER based on the size of the fund’s Assets Under Management. For actively managed equity schemes, the total expense ratio (TER) allowed under the regulations is 2.5% for the first Rs. 100 crore of average weekly net assets; 2.25 % for the next Rs. 300 crore, 2% for the subsequent Rs. 300 crore and 1.75% for the rest of the AUM. For debt funds, the expense ratio limits are lower.
Under the regular plan, an equity fund can theoretically charge the maximum permitted TER. For the direct plan, the TER will usually be lower.
This can potentially result in a noticeable difference between return potential over long holding periods.
Read Also: Difference Between Large Cap, Mid Cap, and Small Cap Funds
Impact of long-term investing on direct vs regular small cap funds
The expense ratio is expressed as a percentage of the scheme’s average Net Asset Value (NAV). Since daily NAV is reported after subtracting expenses, the TER directly influences it. A lower expense ratio means fewer costs are deducted, which in turn results in a higher NAV for the scheme.
Over time, this cost difference can lead to slightly higher NAVs and enhanced compounding potential for direct plans. While the difference is minimal in the short term, over the long-term benefit of reduced expenses may become more pronounced with each additional year of investment.
However, it’s important to note that cost savings alone do not guarantee better outcomes. In direct plans, the responsibility of fund selection lies entirely with the investor. A scheme that underperforms or misaligns with your goals or risk profile can potentially erode the benefit of a lower TER over time.
How to choose between direct and regular small cap funds
As an investor, how should one decide between direct plan mutual funds vs regular plan mutual funds? Some points to help assess the same are:
- Assess comfort with self-research. If you can shortlist schemes and conduct your own market research, a direct plan may be suitable.
- Check TER on the scheme factsheet to assess the difference.
- Evaluate service value. A distributor can help you identify a suitable scheme based on your goals and risk appetite. They can also help with transactions, portfolio monitoring, statements and the like. If this assistance is important for you – scheme selection can be challenging and requires a degree of market knowledge and behavioural insight – the regular plan’s extra fee can be worthwhile.
Taxation aspects to consider
Current equity fund rules (post Budget 2024) apply equally to direct and regular plans:
- Short-term capital gains (holding ≤ 12 months): taxed at 20%.
- Long-term capital gains (holding > 12 months): taxed at 12.5% on gains exceeding Rs. 1.25 lakh per year.
- A switch from a regular to a direct plan within the same scheme code is treated as a redemption‐plus-repurchase and therefore may trigger capital gains tax.
Read Also: Flexi Cap vs Small Cap Funds: Key Differences and Which is More Suitable?
Which one should you pick?
You should choose a direct plan if you:
- Are comfortable making fund selections and monitoring performance.
- Want to lower costs to capture more growth potential.
- Understand that choosing scheme misaligned with your goals can offset cost savings.
Whereas, you should stick with a regular plan if you:
- Need personalised guidance, periodic rebalancing, or behavioural coaching.
- Value a single human point of contact more than the TER percentage you may save.
Conclusion
Direct and regular small cap funds invest in the fund. The key difference is cost, and cost directly influences potential net returns, especially over multi-year horizons. For investors who can independently navigate their investment journey, the direct plan’s lower TER offers a more cost-effective route to small cap growth potential. However, those who prefer assistance and guidance in scheme selection and portfolio management may find the extra fee worthwhile. After all, investing in a scheme that doesn’t align with your goals or risk tolerance can also become a cost over time — one that may outweigh the benefits of a lower expense ratio.
FAQs:
What is the main difference between direct and regular small cap mutual funds?
The main difference is that direct small cap mutual funds are purchased without intermediaries and have a lower expense ratio, while regular plans involve a distributor and include commission costs within the fund’s total expense ratio.
Do direct small cap funds always give higher returns?
Small caps purchased under the direct plan typically give higher potential returns than small caps under regular plan because of the expense ratio. However, market performance still dictates the outcome to a larger degree.
Are regular small cap funds suitable for new investors?
The distributor’s support can make regular small caps suitable for beginners who need guidance. However, it is always prudent to align one’s investment decisions to one’s risk tolerance and objectives.
How does the expense ratio affect small cap fund returns?
Every basis point of TER comes directly out of the NAV daily. As a result, the NAV for regular plans is usually lower than that of direct plans.
Can I switch from a regular plan to a direct plan in small-cap funds?
Switching between plans is considered as a redemption and repurchase of units and can trigger capital gains tax implications and exit loads (if applicable).
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