There are advantages but investors should also keep in mind the costs related to switching

A penny saved is a penny earned. Increasingly, mutual fund investors prefer direct plans where there are no intermediary costs involved. In regular plans, the intermediary is paid a distribution fee by the AMC, which is charged to the plan. So, an investor’s return is higher in a direct plan on account of lower expense ratio (typically 20-100 basis points less) than the regular plan of the same fund. The good news is that switching from a regular plan to a direct one is today a matter of just a few clicks, thanks to the many MF aggregator apps and online utilities. If you are keen on switching to direct plans, here is all you need to know.

Expense gap

The total expense ratio (TER) is the fee charged by fund houses to manage the investors’ money in each scheme. The expenses are calculated against the daily average net assets of the fund. The NAV of each day is arrived at after accounting for such expenses.

Under direct plans, the commission paid to intermediaries, such as distributors, is excluded from the expenses charged to investors, thus resulting in a lower expense ratio. For MF investors, this saving can compound healthy returns over the long run. For instance, a 31-year-old using the SIP route to invest ₹10,000 every month in a direct plan where the cost is 1 percentage point cheaper can get a corpus of ₹57.27 lakh at the end of 20 years, compared to ₹51 lakh with a regular plan, assuming 8 per cent annual return in both cases. That’s ₹6 lakh more for the SIP route. If the same individual did a lump sum investment of ₹5 lakh, at the end of 20 years he/she would accumulate ₹4 lakh more when going direct.

Mind the costs

However, investors should keep in mind other costs related to switching. Switching from regular to direct plan is considered as redemption in the old scheme and fresh investment in the new scheme even if they are practically the same fund. Hence, the switch transaction may attract capital gains tax — short term or long term, depending on the holding period and the category of fund (equity or debt).

If debt funds are sold within three years of purchase, the capital gains are treated as short-term gains -- taxed as per an individual’s respective slab rates. If the debt MF is held for three years or more, the gains are taxed as long term at 20 per cent with indexation. For equity MFs, the cut-off period of holding is 12 months for the purpose of determination of long-term or short-term capital gains. While the long-term capital gains on equities and equity oriented MFs are exempt up to ₹1 lakh a year (aggregate), the rest is taxed at 10 per cent. Short-term gains in equity MFs are taxed at the rate of 15 per cent. For SIP investors, the date of each investment shall be separately considered to arrive at such capital gains tax. Also, exit loads, if applicable, can reduce your redemption amount while switching to a direct scheme. Hence, investors need to run a thorough check on such items, before jumping the gun on switch transactions. Moreover, in the case of ELSS schemes, such a switch to direct plan may not even be permitted before the expiry of the lock-in period.

How to switch online

For today’s tech savvy investors, switching routes are aplenty. One, you can directly put in a request on the fund house’s website, upon registering with a username and password. Two, you can register yourself on the website or apps of the Register & Transfer Agents (RTAs) — CAMS and Karvy. Switching through the RTA route would be beneficial for those who have invested with multiple fund-houses. Three, MF aggregator apps such as Kuvera and Groww allow switching from regular to direct plans. For switching requests placed before 3 pm, the same day’s NAV would be applicable, and the switching would be done on the same day. However, if the request is placed after 3 pm, the process would be done at the next working day’s NAV.

The jury is still out on whether choosing a direct plan is beneficial for all types of investors. Expenses shouldn’t be the only factor that you should consider while investing. Whether you have enough knowledge to pick the right fund and have the right knowledge to maintain your portfolio are critical. The right fund but regular plan is always better than wrong fund but direct plan.