When switching to direct funds, keep taxation in mind

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Many investors shift from regular to direct equity mutual funds when they realise the benefit. In a regular scheme, a fund house pays a commission to the agent. The expense ratio in a direct mutual fund is minus the commission.

Take an example of the large-cap funds’ category. The largest actively managed fund is ICICI Prudential Bluechip Fund, with 27,033 crore assets under management (AUM). According to data from Value Research, the difference in the expense ratio of the direct (1.21%) and regular (1.72%) fund is 0.51 percentage points.

The difference can be significant over the long term, and when the invested amount is large.

So, if you decide to switch from a regular to direct scheme of the same fund, should you withdraw all your investment at once or do it partially? According to investment advisors and mutual fund distributors, it depends on taxation.

“Every financial year, there is no long-term capital gains up to 1 lakh in equities. If an investor sells stocks and equity mutual funds where the profit is 1 lakh, he or she won’t need to pay tax. Therefore, when switching from regular to direct plans, an investor should withdraw units in such a way that the gains are below 1 lakh,” said Malhar Majumder, a Kolkata-based mutual fund distributor and partner, Positive Vibes Consulting and Advisory.

The switch should, therefore, be over time so that the investor saves tax.

But if you are switching from an underperforming fund to a better one, you can withdraw the entire amount. “If the fund is underperforming, it’s better to shift to a better fund. The money that investors would lose due to underperformance could be higher than the tax outgo,” said Majumder.

When investing in a direct plan or a fund that you think is better than the previous one, you can invest a lump sum amount instead of doing a systematic investment plan or SIP. It will be a continuity of the investment. Investors won’t need to average the cost of buying in such a case.

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