Investing in mutual funds has gained traction in the final couple of years. However, the total penetration of mutual funds in India is nonetheless low in particular due to a lack of economic awareness and literacy amongst investors.
To begin with, one demands to have correct understanding of mutual funds ahead of beginning to invest. For instance, even even though direct plans of any mutual fund scheme are broadly recommended now, one demands to be particularly cautious ahead of jumping onto them. If you want to invest straight, you have to have to have a very good grasp of investing and an understanding of the many objectives of investment.
With typical plans, intermediaries like brokers, distributors or banks work as the middle man in between the investor and the AMC (Asset Management Company) and charge commission or brokerage to provide the services. Direct plans, as the name suggests, lets the investor invest straight with the AMC or the fund residence. There is no involvement of third party brokers or distributors or banks. Hence, there is no commission or brokerage involved.
The greatest aspect is as an current investor, you can also switch your current typical mutual funds to direct plans. However, hold in thoughts that they will be taxed differently.
Here is how taxation plays a part when switching to direct funds
Switching from the typical fund to the direct fund of the identical mutual fund scheme outcomes in the redemption of the units an investor holds of the typical fund. Archit Gupta, Founder and CEO, ClearTax says, “An investor will have to buy the units of the direct fund after redemption of the units of a regular fund, as there is no ‘transfer’ of the units happening between the schemes. As an investor redeems their investments in the regular fund, they will essentially attract taxes.”
For instance, with equity-oriented funds, if your holding period is shorter than 1 year, you will have to spend quick-term capital gains tax (STCG) at 15 per cent. In case of the holding period exceeding 1 year, you will attract extended-term capital gains tax (LTCG) at 10 per cent if the gains are in excess of Rs 1 lakh a year, and there is no advantage of indexation supplied. Note that, you will also have to spend the applicable cess and surcharge on your capital gains.
In the case of debt funds, your capital gains will be termed ‘short-term’ if your holding period is shorter than 3 years. These gains are then added to your general earnings and taxed at your earnings tax slab price. You realise extended-term capital gains if the holding period is longer than 3 years. These gains are taxed at 20 per cent immediately after indexation. As an investor, you will also have to spend the applicable cess and surcharge.
Apart from the tax on capital gains, an investor will also have to spend the securities transaction tax (STT) on acquiring and promoting equity fund units. They will also be necessary to spend stamp duty on the obtain of new units of the direct fund at .005 per cent. Gupta says, “Investors may also have to bear the exit load on early withdrawals. One should keep all taxes and charges in mind before deciding to switch from regular to direct funds.”
He additional adds, “There is no doubt that the returns offered by direct funds are slightly higher than regular funds as there are no commissions or third-party charges involved. However, switching to direct funds may come at a considerable cost. The slightly higher return you are going to earn may be negated by the associated costs.”
What are the dos and don’ts for investors?
Industry specialists say, investors have to have to play it sensible when they are deciding to switch from typical to direct funds. It is advisable not to make early exits from the typical strategy as exit load (based on the fund strategy) could be charged.
Gupta says, “One may consider switching to direct funds only if he/she is sure that the associated costs of switching with slightly higher returns from direct funds will be recovered. If one’s investment horizon is shorter, it would not be a wise move to switch as the cost of switching will be higher and it is unlikely that the gains will be significantly higher than the cost of switching.”