How to switch from a regular plan to a direct plan

Starting with mutual funds is the smartest decision for building wealth in the long run. But embarking on the journey can seem daunting at first. As a result, many first-time investors opt for the guidance of a mutual fund advisor, and in the process, they invest in regular plans. But did you know these plans come with higher costs that can significantly impact your long-term returns?

Regular plans charge a higher expense ratio - sometimes even 1 per cent higher than direct plans. While this might seem negligible, it adds up significantly over time due to the power of compounding.

That's why, in this article, we illustrate some examples to explain why you should make the switch to a direct plan. But first, let's discuss the process of making this switch. This will help you better understand the tax implications of making this change.

How to shift to a direct plan

To switch from a regular plan to a direct plan, you need to redeem your investments. Then, you have to reinvest them. Whether it is the same fund's direct plan or some other fund is entirely your choice. So, here are the three key considerations to have in mind when redeeming your investment.

• Lock-in Period: If you've invested in tax-saving funds like ELSS (Equity Linked Savings Schemes), they come with a mandatory 3-year lock-in period. You can't redeem your investments until this period ends. As a result, you'll have to wait before the lock-in period ends to make the switch.
  
• Exit Load: Some fund houses charge an exit load if you redeem your investments within a given timeframe, typically 1 year. Check your fund's exit load policy to avoid unnecessary costs.
  
• Capital Gains Tax: Switching from a regular plan to a direct plan involves redeeming units in your existing fund and reinvesting in the direct plan. In the case of equity-oriented funds, this can trigger capital gains tax:
  
• Short-Term Capital Gains (STCG): Taxed at 20 per cent if units are held for less than 12 months.
  
• Long-Term Capital Gains (LTCG): Taxed at 12.5 per cent for gains exceeding Rs 1.25 lakh annually.

Suggested read:
Things to know before switching from a regular to a direct mutual fund plan

How to invest in a direct plan

1. Fintech Platforms
Platforms like Groww, Coin by Zerodha, etc., allow investors to access funds from multiple AMCs via a single account. With online KYC and linking of bank accounts, setting up takes just a day. Also, the customer support personnel aid in the onboarding process.

2. MF Utilities (MFU)
MFU is a shared platform from various AMCs where investors can create a Common Account Number (CAN) to view and manage a consolidated portfolio. It supports investments in direct funds via lump sum or SIPs.

3. AMC Websites
Invest directly through AMC websites by completing a one-time KYC with PAN, address proof, and bank details. With every AMC, you're limited to their funds, and if you want to invest in another AMC's fund, you need to open a new account. However, you don't need to redo your KYC.

4. Offline Investing
Visit an AMC branch with proof of identity, PAN, and bank details to complete KYC. Fill out the mutual fund or SIP form and select the "Direct" option to invest. A folio number will be provided for tracking your investment.

Suggested read: How to invest in direct plans of mutual funds?

The impact on long-term returns

The primary reason for making the change is the difference in expense ratios. Direct plans eliminate intermediary fees, allowing you to retain a larger portion of your returns. Let's break this down with an example:

Let's suppose that the difference between a regular plan and a direct plan's expense ratio is 0.5 per cent.

• Regular Plan: Expense Ratio = 1.5 per cent
  
• Direct Plan: Expense Ratio = 1.0 per cent

Now, imagine you invest Rs 10,000 per month via SIP in a mutual fund offering 12 per cent annual returns over 20 years.

A regular plan would make you Rs 86 lakh. Not bad, right?

On the other hand, a direct plan guns out Rs 91 lakh. That's a difference of Rs 5 lakh!

This difference is purely due to the lower expense ratio of the direct plan. Over decades, the impact of compounding magnifies these savings, making direct plans a superior choice for long-term investors.

Suggested read: Direct vs regular mutual fund: Which one should you invest in?

Benefits of making this change

Switching to a direct plan comes with several benefits:

1. Lower expense ratios

Direct plans eliminate distributor commissions, reducing the cost of investment. This means more of your returns stay invested, accelerating wealth creation.

2. More control

Too many investors apply a set-it-and-forget-it strategy without knowing what's going on with their investments. With direct plans, you have complete control. You deal directly with the AMC, eliminating intermediaries and ensuring you're well-informed about your fund's performance.

3. Ideal for Experienced Investors

If you've gained some knowledge about mutual funds or have access to our platform, Value Research Fund Advisor, switching to direct plans is a logical next step. This is because we guide you through the best practices for choosing mutual funds. Also, we give you expert recommendations that ensure you make a better decision for the long term.

Suggested read: Are you a DIY investor?

Should you switch to direct plans?

While you'll retain more of your returns, making the switch to direct plans requires a level of confidence and experience. That said, the cost savings and potential for higher returns far outweigh the tax bill. We've even done a quick study of how much time it will take you to outpace a regular plan if you decide to switch to a direct plan.

Here's a helpful tip for making the switch. But it applies to equity-oriented mutual funds, which also include hybrid funds having more than 65 per cent of assets invested in equity. If your holdings have crossed a year, then redeem them. And make sure your gains remain within the exemption limit of Rs 1.25 lakh for each year. This way, you'll have to pay no taxes upon redemption. Then, keep doing this year after year, reinvesting the sum in direct plans.

If you're planning to change up your mutual fund portfolio, then you should try out Value Research Fund Advisor. Our platform offers helpful portfolio insights to make you a smarter investor. You'll get expert fund recommendations and an in-depth analysis of your portfolio, thus setting you up for long-term investment success.

Also read: What are direct mutual funds

This article was originally published on January 08, 2025.