In mutual fund investments, one crucial decision that investors often grapple with is whether to stick with regular plans or make the switch to direct plans. The primary differentiator between these two options lies in the expense ratio, with regular plans incurring higher costs due to the commission paid to mutual fund agents.
Understanding expense ratio
An expense ratio is the cost of owning a mutual fund or ETF. Think of the expense ratio as the management fee paid to the fund company for the benefit of owning the fund. The expense ratio is measured as a percentage of your investment in the fund.
While a 1% difference may seem marginal, the impact over time can be significant, as illustrated in the tables below.
|Investment Worth (Direct plan)
|Investment Worth (Regular plan)
|Difference in Investment Worth
|Rs 8 lakh
|Rs 10.50 lakh
|Rs 10.20 lakh
|Rs 15 lakh
|Rs 34.50 lakh
|Rs 32.80 lakh
|Rs 1.70 lakh
|Rs 22 lakh
|Rs 80.20 lakh
|Rs 74.50 lakh
|Rs 5.70 lakh
|Rs 30 lakh
|Rs 1.75 crore
|Rs 1.50 crore
|Rs 25.00 lakh
Over 20 years, the disparity between direct and regular plans can accumulate to a staggering Rs 25 lakh, emphasizing the long-term impact of the expense ratio difference.
One might wonder about the tax implications of switching from a regular to a direct mutual fund plan. Indeed, taxes are involved, but they should not serve as a roadblock. Whether you sell your regular fund or not, taxes will come into play eventually. To emphasize this point, let’s consider a real-world scenario.
|Value of Investment (Dec 21, 2023)
|Rs 35 lakh
|Tax Liability on Switching to Direct Plan
|Rs 1.75 lakh
|Value of Investment After Tax Liability
|Rs 35 lakh
|Rs 33.25 lakh (35 lakh – 1.75 lakh)
|Returns (% p.a.)
|When will the Funds have Similar Corpus?
|After 5 years
|After 5 years
|Value of Investment After 20 Years
|Rs 7.74 crore
|Rs 8.98 crore
Even with the tax hit from switching, the direct plan catches up with the regular plan in just over six years. Over a 20-year horizon, the direct plan could make you richer by a whopping Rs 1.24 crore. This analysis underscores the financial wisdom of enduring the short-term tax implications for the long-term gain associated with direct plans.
Considerations before investing
Before making the switch, it’s essential to consider some key factors. Exit load, a percentage deducted from the Net Asset Value (NAV) at the time of redemption, may apply if you exit the mutual fund scheme within a specified period. Additionally, certain funds, such as Equity-Linked Savings Schemes (ELSS), have mandatory lock-in periods, preventing an immediate switch from a regular to a direct plan.
Capital gains tax is another aspect to be mindful of when exiting the regular mutual fund plan. To mitigate tax liability, consider transferring the amount to the direct plan gradually. Spreading investments across 12-15 months can help reduce the impact of capital gains tax. Furthermore, seizing opportunities during market corrections can be an optimal time to make these shifts, as some capital gains may erode during market downturns.
It’s crucial to note that exit load, lock-in periods, and taxation may vary if you’ve invested through Systematic Investment Plans (SIPs). Each SIP installment is considered separately for calculations, particularly relevant for funds with lock-in periods.
The decision to switch from a regular to a direct mutual fund plan involves weighing the short-term tax implications against the long-term benefits of lower expense ratios and potentially higher returns. For those with a five-year or longer investment horizon, enduring the tax hit and making the switch to a direct plan may prove to be a prudent financial move. However, investors with shorter timeframes may find the process of switching unnecessary. Ultimately, a well-informed decision based on individual financial goals and circumstances is paramount in navigating the complex landscape of mutual fund investments.