Mutual funds: Why direct plans are stealing the show

livemint.com:

₹10 lakh over a five-year period in a regular plan and the current value of the investment is ₹18 lakh. This implies a profit of ₹8 lakh and you are liable to pay taxes on the profit during redemption. Now, since the investment horizon was more than one year, you have to pay a 10% long-term capital gains tax on the gains made.

This comes to around ₹80,000. That is the cost you have to bear while converting from a regular to a direct plan. When you opt for a direct plan, you would be reinvesting a lower amount, say ₹17.2 lakh in this case, since you have paid ₹80,000 as taxes.

However, if you continue with the regular plan at this juncture, the original amount continues to compound. According to a calculation by Mint, assuming the investments compound at a 12% rate annually, and the expense ratio of regular and direct plans is 2% and 1%, respectively, it would take roughly six years for the direct plan to start beating the regular plan. Note that this six-year lag is due to the switching cost incurred while shifting from a regular to a direct plan.

Another point to consider is that the gains are not taxed if it is less than ₹1 lakh. This means you do not have to pay any capital gains tax if your gains are less than ₹1 lakh in a year. In that case, you can redeem your investment without incurring any capital gains tax.

Also, gains made before 31 January 2018 are not eligible for capital gains tax since the decision to tax capital gains on equity mutual funds was taken only after that date. Dev Ashish, founder of Stable Investor, a Sebi registered investment adviser, said those who have accumulated large capital gains can exit regular funds in a phased manner. This can be done so that they redeem only up to ₹1 lakh of