If you’ve ever tried to compare mutual funds, chances are you’ve come across two popular categories – Fund of Funds (FoF) and Direct Mutual Funds. Both these instruments help investors diversify their financial portfolio and grow resilience. However, they work differently. As an investor, you might not be sure which of them suits your goals. That’s exactly what we have explained in this blog.
Read on to know how FoF differs from direct mutual funds and which of these could be right for you.
What is a Fund of Funds?
You can consider a fund of funds a basket of mutual funds. An FoF doesn’t directly buy stocks. Instead, it allocates your investments into a portfolio of other mutual funds.
Let’s take an example. An international FoF may allocate your assets to global equity funds. A hybrid FoF, on the other hand, may mix debt, equity, and gold through multiple underlying funds.
With FoFs, investors gain easy access to global markets. They are suitable for investors who prefer convenience. The higher degree of diversification reduces the risk of concentration.
What is a Direct Mutual Fund?
A direct mutual fund is the simple version of mutual funds that invests in the stocks of companies. Since you avoid commissions for distributors, these funds come with lower expense ratios.
If you’re someone who does your own research and compare mutual funds, direct plans are a cost-effective strategy to grow your wealth.
The lower expense ratios of direct mutual funds reduce your costs over time. With transparent information available on the underlying assets, you can make informed decisions. Altogether, investors enjoy better control over their portfolios with direct mutual funds.
Key Differences Between FoF and Direct Mutual Funds
FoF and mutual funds differ in several ways, as explained in this section.
Cost and Expense Ratio
If you’re willing to keep more of your gains for yourself, direct mutual funds are a better choice. They come with a single-layer expense ratio. No commission for distributors is deducted.
FoFs, on the other hand, carry a double layer of fees. This involves the expense ratio of the FoF itself and that of the underlying funds.
Diversification
Those looking to diversify their portfolios without extensive research often choose FoFs. When you invest in a single FoF, you gain exposure to multiple asset classes and demographics.
However, with direct mutual funds, you need to build a diversified portfolio by putting in your own efforts for research.
Returns Potential
In the long run, the returns from direct mutual funds tend to be slightly higher since you need not bear a higher expense ratio.
On the other hand, even if the underlying funds of an FoF perform well, the additional cost layer marginally reduces the final return.
Risk Management
Investors looking to spread their risk across multiple baskets find FoF a better choice. Since they allocate your funds across multiple funds, your exposure to a single fund manager or asset is reduced.
Transparency & Control
Direct funds are more transparent. Investors get a clear picture of the assets that the fund is holding. You can also compare mutual funds across different categories.
On the other hand, FoFs add a layer between the investor and the underlying holdings.
Conclusion
Should you invest in an FoF, or go for direct mutual funds? Your choice largely depends on your investment style. If you’re just getting started with the money market and want simplicity, FoFs are a sound choice. They help investors with instant diversification and global exposure.
However, if you’re someone who takes time comparing funds and exercises maximum control over the portfolio, direct mutual funds will be the smarter choice.
Both these types of funds play a significant role in building long-term wealth. Adopt the right strategy as you invest in FoFs and mutual funds to grow your financial resilience.
