Is it worth switching from regular to direct funds?

Have you initiated your mutual fund journey through a financial advisor or agent? If yes, then you have been investing in regular plans of mutual funds.

But if your financial awareness has expanded and you want to switch to direct plans, here's what you need to know and whether the switch makes financial sense.

Regular plans have a higher expense ratio

The expense ratio of regular plans includes the commission paid to mutual fund agents, which is why it is higher than that of direct mutual fund plans (usually by around 1 per cent).

The 1 per cent may seem small, but it can put a significant dent over time.

To illustrate the impact, let's consider a Rs 10,000 SIP initiated on November 1, 2023, for various time horizons. Using average returns for flexi-cap funds over the last 10 years (14.22 per cent for regular and 15.34 per cent for direct plans), the difference in investment value of regular and direct plans becomes evident.

As you can see, over a 20-year period, the difference can be as much as Rs 18 lakh. This disparity only grows over time.

There is tax involved, but don't let it be a roadblock

But doesn't switching from regular to direct plans incur taxes, you may ask? After all, you are selling your regular fund before switching to a direct fund.

You do. But so do you, even if you don't sell your regular fund. At some point or another, when you finally decide to sell the fund, you'll have to pay the tax.

Even if you want to disregard this point, let's see how a direct fund investment would catch up with a regular plan relatively quickly despite taking a tax hit.

Say you initiated an SIP of Rs 10,000 in the Parag Parikh Flexi Cap Fund's regular plan on November 1, 2013. Fast forward 10 years to October 31, 2023, the value of your investment has reached Rs 30.6 lakh.

Now, contemplating two scenarios - one where you continue with the regular plan and the other where you opt to switch to the direct plan on October 31, 2023 - here's what we find.

As can be seen, even after incurring taxes from the switch, your direct plan investment would rub shoulders with the regular plan in just over six years.

And if you stretch that period to 20 years, the direct plan would make you richer by Rs 1.12 crore.

A word of advice

• We'd suggest you read this article before moving to a direct plan.
  
• Consider spreading your long-term capital gains (LTCG) over some years, as only gains above Rs 1 lakh are taxed each year.
  
• Also, remember the grandfathering clause where gains up until January 31, 2018, remain tax-free.

What you should do

If you plan on investing in that fund for five years or more, endure the tax hit and switch to a direct plan.

However, those with a shorter investment horizon might find the hassle of switching unnecessary.

To check your tax liability, click here .

Suggested watch: Mutual fund 'direct plan' queries answered

This article was originally published on November 17, 2023.