« Are index funds less risky than active funds? What is the best way to invest in US stocks? »

How to switch from regular to direct funds?

Posted on 11 Dec 2021
Author: Sayan Sircar

Tags: Portfolio Review

8 mins read
📢Join 2300+ readers on WhatsApp and get new post notifications!

Investors who have investments in Regular mutual funds should switch to Direct. This post explains how.

How to switch from regular to direct funds?

📚 Topics covered:

Introduction
Step 1: Stop all SIP in Regular funds
Step 2: Use a platform that offers Direct plans
Step 3: Calculate the impact of taxes and switch smartly
- Method one: 1 lakh Equity LTCG exemption limit
- Method two: Loss harvesting
Step 4: Exit Regular plans first when rebalancing
Step 5: Single Switch
Step 6: Review your fund choices

Introduction

We start this article with two statistics:

Mutual fund distributors received around ₹5,500 crores of commissions from AMCs in FY 2020-21 as per AMFI data (source). This means that investors lost that wealth since it could have been a part of their portfolios.
For equity mutual funds, the average difference in returns between Regular and Direct plans in the last year is 1%. On average, the TER of a Direct fund is less than half that of Regular funds as per the latest MF scheme documents and reported by Valueresearchonline.

Investors who wish to learn more about Direct vs Regular mutual funds should read this article first: Do not make this mistake when investing in mutual funds.

The bottom line is: Regular plans have higher expenses or TER than Direct plans. This TER difference is the distributor commission that is currently 1% on average as per the statistics above. Therefore, the TER difference can become 25-30% over the investor’s working life. If you add the 30-40 years of lifespan post retirement, the difference becomes worse.

Gap of returns of Direct vs Regular funds

Investors should understand why they are losing money by investing in Regular funds and switch to Direct plans as soon as possible. A 25% difference in lifetime corpus value is between 7.5cr and 10cr as retirement corpus. So if you can manage retirement with 7.5cr, your distributor just needs three clients like you to manage their retirement. The investor has worked and invested for 30 years to reach this position under the guidance of the distributor, who ensured that he never switched away.

We discuss a few ways to switch from Regular to Direct plans for any investor. A Direct fund will have the word DIRECT in the name, and without the word DIRECT in the name, the fund is a Regular fund.

An exit from the Regular fund will involve selling units, leading to capital gains taxes. The impact of these taxes is one time. However, the lower returns in Regular funds will persist throughout the holding period. Since we are reducing expenses, we always prefer switching those units with the highest TER first.

Additionally, funds that declare dividends (IDCW plans) should also be avoided since dividends are taxed at the investor’s highest slab rate and reduce overall returns. Investors, therefore, should also switch from IDCW to Growth using the same methods described below.

Step 1: Stop all SIP in Regular funds

This step is the most obvious and ensures that no new money is entering the Regular plan. This step can be done online from the AMC website (log in using PAN and Folio number from account statement), CAMS, or Karvy websites. In the worst case, visit your nearest CAMS, Karvy office, to fill and submit a SIP cancellation form.

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

Step 2: Use a platform that offers Direct plans

In order of preference, these would be:

AMC website
Registrar websites like CAMs and Karvy which allow transactions in all funds serviced by them
AMC owned portals like MF Utilities which supports almost all MFs in India
Direct plan portals: a simple Google search like “invest in direct funds in India” will bring out several such portals

Many of these platforms also offer Regular plans, so check that the fund name has the word Direct. Bank and stock brokers usually offer Regular plans. Please check the fund names before investing.

Step 3: Calculate the impact of taxes and switch smartly

As described in this post on how to calculate taxes and perform tax harvesting, we will see how we can exit with the least taxes to be paid.

Method one: 1 lakh Equity LTCG exemption limit

Profits on selling equity fund units purchased over one year are called long term capital gains (LTCG). LTCG is tax-free up to ₹1 lakh per financial year. Investors can wait until March to see how much equity LTCG they have accumulated over the year and, for the rest, sell just enough units from the Regular fund to reach up to 1 lakh in gains which is tax-free.

For example, you calculate on 10 March that you have sold 3 lakhs of equity MF till date in that financial year, which has led to ₹20,000 of LTCG. This means that you can sell additional units over a year old up to ₹80,000 of profits. So start with the Regular funds with the highest TER and sell enough units to reach up to ₹80,000 in profits. If you exceed the total of ₹100,000 in profits, you will have to pay 10% tax on the amount over a lakh.

Method two: Loss harvesting

Since losses can be offset against gains, if you have losses in some funds, you can sell them and offset that loss against profits in selling other funds. The tax rules say

Long term losses must be offset against only long term gains
Short term losses can be offset against both short and long term gains
As long you file returns every year, both short and long term excess losses can be carried forward for eight years

Since taxation rules may change every year, investors should check the current IT rules before doing anything.

Investors should be mindful of how much the tax is, as a percentage of the amount sold, relative to the TER difference. For example, if the tax is 5% and the TER difference is 1%, that is 5 years of TER, almost that is lost to taxes. In such a case, explore step 3 below.

Step 4: Exit Regular plans first when rebalancing

If the taxation is too much related to the TER difference, sell these funds first when rebalancing.

This post covers the details on how and why of rebalancing: Portfolio rebalancing during goal-based investing: why, when and how?

Step 5: Single Switch

Suppose you switch to the Direct plan of the same fund (XYZ Regular Plan to XYZ Direct Plan) or from equity to equity (or from debt to debt). In that case, you can do so in a single transaction. There is no need to time the market based on current levels since you move within the same asset class, either equity or debt.

If you are moving from equity to debt or vice versa, ensure that your asset allocation is appropriate for your goals post the switch. Read more here: What should be the Asset Allocation for your goals?. If you end up with a large amount due to switches, use this chance to fix your asset allocation for your goals.

Step 6: Review your fund choices

Suppose you have invested in high TER active funds. In that case, this is an excellent opportunity to switch to low TER active funds or simple index funds. This step not only reduces portfolio cost and simplifies portfolios, but the investor will also benefit from the impact of less active decision making in managing their portfolio. This point is made in more detail in the following posts:

Ultimately, the investor should understand the negative impact of distributor commission on their future portfolio values and make every effort to switch to Direct plans. The tax they will be paying today will be a minuscule percentage of the benefit to their portfolio over decades. Our official recommendation will be a one time switch from active equity funds to index funds. Investors requiring fund names to invest can benefit from the fund choosing methodology described in this post: Which funds should I invest in?.

If the investor needs advice on the choice of funds, they have the option of engaging with a SEBI Registered fee-only investment advisor for creating a complete financial plan including fund recommendations. However, if the Do-it-yourself (DIY) route is preferred, there are many online resources for educational purposes. For example, they can start here to educate themselves about the goal-based investing process.

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

To understand how this article can help you:

If you have a comment or question about this article

The following button will open a form with the link of this page populated for context:

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Worked out case studies for goal-based investing

Case study: how can this middle-aged investor with two children plan for retirement and children's goals?

This article shows how a single-income middle-aged couple with two small children reach their retirement and children’s goals.
Case study: can this double income single kid family reach FIRE at 50?

This article shows how a double-income couple with a 2-year old reach their FIRE dream at the age of 50.
Case study: how a family in their mid-30s with a newborn kid can FIRE and invest in real estate?

This article shows how a double-income couple with a newborn child can invest for their future goals of FIRE and real-estate investment.
Case study: how this double income recently married family can perform DIY goal-based investment planning

This article shows how a young just-married couple can invest for future goals using the Arthgyaan goal-based investing tool.
Case Study: How should couples in their 40s with a new baby plan their financial future?

Did you welcome a bundle of joy in your 40s? This article will discuss ways of planning the child’s (and your’s financial future)
Case study: how this double income single kid family can perform DIY goal-based investment planning

This article shows how a very typical salaried couple with one child can invest for future goals using the Arthgyaan goal-based investing tool.

Previous and next articles:

<p>Understanding the risk of every asset class in our portfolio is essential. This article talks about the risk in index funds.</p>

Portfolio Construction Risk

Are index funds less risky than active funds?

Understanding the risk of every asset class in our portfolio is essential. This article talks about the risk in index funds.

Published: 10 December 2021

7 MIN READ

<p>The recent bull market rally in US markets is generating a lot of interest in US stocks. How should you invest?</p>

Choosing Investments International Investing

What is the best way to invest in US stocks?

The recent bull market rally in US markets is generating a lot of interest in US stocks. How should you invest?

Published: 12 December 2021

6 MIN READ

Latest articles:

<p>This article shows how to understand the impact on your portfolio if you stop investing for a few years between today and retirement.</p>

Portfolio Construction

How much lower portfolio value do you end up with if you do not invest for a few years in between?

This article shows how to understand the impact on your portfolio if you stop investing for a few years between today and retirement.

Published: 24 April 2024

4 MIN READ

<p>This article explains what happens if you withdraw from your EPF to buy a house and who should or shouldn’t withdraw from EPF for this reason.</p>

House Purchase

Should you withdraw from your EPF to buy a house?

This article explains what happens if you withdraw from your EPF to buy a house and who should or shouldn’t withdraw from EPF for this reason.

Published: 21 April 2024

7 MIN READ

Topics you will like:

Asset Allocation (21) Basics (8) Behaviour (12) Budgeting (12) Calculator (25) Case Study (6) Children (17) Choosing Investments (40) FAQ (12) FIRE (13) Gold (21) Health Insurance (5) House Purchase (29) Insurance (16) International Investing (12) Life Stages (2) Loans (17) Market Data (7) Market Movements (16) Mutual Funds (46) NPS (7) NRI (19) News (18) Pension (8) Portfolio Construction (53) Portfolio Review (27) Reader Questions (8) Real Estate (7) Research (5) Retirement (38) Review (15) Risk (6) Safe Withdrawal Rate (5) Set Goals (28) Step by step (15) Tax (59)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.