Regular schemes of mutual funds involve a high cost to Clients in terms of commissions. A lot of Clients in regular schemes are now learning about the magnitude of this cost over the years as their portfolio size multiplies. Due to this, they are looking to switch from regular to direct schemes. While I am not going here into the merits of direct vs. regular schemes, this blog focuses on if a Client has decided to move from regular to direct funds then what are the main things he / she should consider.
1)     Tax Implications – While going from regular to direct schemes there are going to be tax implications:
a.      Long term / short term gain: Before selling / switching your scheme, please understand whether it will attract short term or long term capital gain tax. On equity mutual funds long term capital gains tax is 12.5% whereas short term capital gain tax is 20%. It may be beneficial to hold the fund for a few more months to save the 7.5% tax even though it would entail higher expense of a regular scheme for those extra months.
b.      Long term capital gain limit of INR 1.25 lakhs: Annual long term gain of upto INR 1.25 lakhs is exempt for any income tax. An investor needs to evaluate the cost / benefit of realizing all gains immediately vs. delaying a portion of gains to the next financial year. For example, if an investor has a portfolio which if redeemed would give long term gains of INR 2.25 lakhs on a total portfolio value of INR 5 lakhs. If all this was redeemed in the same financial year it would result in long term capital tax of INR 12,500 ((2,25,000-,1,25,000) X 12.5%). However; if INR 1.25 lakh was realized in current financial year and the balance in the next financial year, there would be 0 tax payable and the investor would only need to pay the higher cost of regular schemes for those additional months.
c.      Surcharge on income tax – Even after evaluating long term and short term gains, there is a question of evaluating your total income for the financial year along with gains from mutual fund redemption. This is important because in some cases, gains from mutual funds can take your taxable income over INR 50 lakhs, in which case your entire income tax would be subject to a 10% surcharge and if the gains take your total income to over INR 1 crore then the surcharge would increase from 10% to 15% on your income tax. Basis this calculation it may be beneficial to postpone redeeming a portion of redemption to the next financial year.
2)     Exit Loads – Exit loads are levied if funds are redeemed within a certain timeframe, most typical being 1% exit load if redeemed before a year. Again a cost benefit analysis needs to be done of exit load vs. cost of regular scheme to see if it is beneficial to redeem immediately or wait for cooling period of exit load.
3)     Portfolio construction – Since Client is in regular schemes, the portfolio would have been built by a mutual fund agent / distributor. There is a high chance of scheme selection being done without any regards to goals or risk profiling of Client. Also, schemes with high expense ratios may be a part of the portfolio. Since the process of moving from regular to direct funds involves redeeming existing scheme anyways, it is a good time for the Client to reconstruct his portfolio based on short term / long term goals.
4)     Mode of Redemption / Investment – If you are in regular schemes, you can ask your agent through which you have invested to redeem the funds. However; a few Clients do not want to have this conversation with their agent due to their prior relationship. In this case they can redeem or switch through the AMC website. There are also multiple websites such as www.kuvera.in, www.mfcentral.com , www.groww.in which allow Clients to invest in direct schemes. The Client can use these websites for redeeming / switching their regular funds as well. If the Client chooses to invest directly through AMC websites, he can use the sites above to have a consolidated view of their portfolio across various AMCs.
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