Direct vs. Regular Mutual Funds: A ₹20 Lakh Investment Comparison

When investing substantial amounts, even a small difference in returns can lead to significant gains or losses over time. One critical decision investors face is choosing between regular and direct mutual fund plans. While both invest in the same underlying assets, the cost structures differ, affecting overall returns.

Understanding Regular vs. Direct Plans

• Regular Plans: These involve intermediaries like brokers or distributors, who receive commissions. The expense ratio is higher due to these commissions.
  
• Direct Plans: Investors purchase directly from the fund house, eliminating intermediary commissions, resulting in a lower expense ratio.
  
  

The difference in expense ratios between the two can be around 1% or more annually.

Case Study: ₹20 Lakh Investment in HDFC Top 100 Fund

Let’s consider an investment of ₹20 lakhs in the HDFC Top 100 Fund over a 10-year period.

• Regular Plan:
  
  
  • Expense Ratio: Approximately 1.62%
    
  • 10-Year CAGR: Around 12.59%
    
  • Future Value: ₹20 lakhs growing at 12.59% CAGR for 10 years results in approximately ₹65.5 lakhs.(Dezerv)
    
    
• Direct Plan:
  
  
  • Expense Ratio: Approximately 0.99%
    
  • 10-Year CAGR: Around 13.22%
    
  • Future Value: ₹20 lakhs growing at 13.22% CAGR for 10 years results in approximately ₹70.4 lakhs.
    
    

Difference: The direct plan yields about ₹4.9 lakhs more over 10 years.(Business News Today)

This example illustrates how the lower expense ratio in direct plans can lead to higher returns over time.

Switching from Regular to Direct Plans

Investors holding regular plans might consider switching to direct plans to benefit from lower expenses. However, concerns about capital gains tax often deter them.

• Capital Gains Tax:
  
  
  • If the investment is held for more than a year, long-term capital gains (LTCG) tax applies.
    
  • LTCG exceeding ₹1 lakh is taxed at 10% without indexation.
    
    

Despite the tax implications, switching can be advantageous in the long run.

Example:

• Suppose an investor switches from a regular to a direct plan, incurring a capital gains tax of ₹50,000.
  
• The annual savings from the lower expense ratio in the direct plan is ₹20,000.
  
• The tax paid would be recovered in 2.5 years through expense savings.
  
• Beyond this period, the investor benefits from higher returns due to the lower expense ratio.
  
  

This example demonstrates that, despite the initial tax outlay, switching to a direct plan can be financially beneficial over time.