Is Mutual Fund Switching Beneficial? Key Considerations

When it comes to managing investments, flexibility is often a key consideration for many investors. This is where mutual fund switching comes into play. Much like switching jobs for career growth or switching a phone plan for better deals, switching mutual funds can provide an opportunity to enhance your portfolio and maximise returns.

But the question arises: is mutual fund switching truly beneficial? In this article, we will explore the concept of mutual fund switching, its potential advantages, the costs involved, and when it makes sense to consider making a switch.

What Is Mutual Fund Switching?

Mutual fund switching involves transferring your investment from one scheme to another. It’s a simple process of selling your units in one fund and purchasing units in another. While the process itself may seem straightforward, it’s important to understand the implications of making such a switch.

When you switch from one mutual fund to another, it is treated as a sell transaction in the original scheme and a fresh purchase in the new one. This can lead to certain costs, such as exit loads and taxes on capital gains, depending on the holding period and the type of fund involved.

For instance, if you decide to switch from an equity fund to a debt fund, you may incur short-term capital gains tax if the equity investment has been held for less than a year. Additionally, some funds may impose an exit load, which is a fee deducted from the proceeds of your investment when you switch.

Know More About How To Switch To Direct Plan From Regular Plan?

Types of Mutual Fund Switches

Switch within the same fund house: This involves transferring investments between schemes managed by the same mutual fund company. This can be a straightforward process and may involve minimal paperwork or even a simple online request.
Switch between different fund houses: This requires redeeming the units in one fund house and purchasing them in another. This type of switch can be a bit more time-consuming and may involve additional steps such as transferring funds to your bank account before reinvesting.
Switch from regular to direct mutual funds: If you’ve been investing in regular mutual funds through a distributor, you may consider switching to direct plans to save on commission fees. Direct plans generally offer higher returns as they do not have intermediary charges.

Benefits of Switching Mutual Funds

Asset rebalancing

Over time, the performance of various asset classes (equities, bonds, cash, etc.) may change. Asset rebalancing involves adjusting your portfolio to maintain a specific asset allocation based on your financial goals and risk tolerance. If your initial asset allocation was 50% equity and 50% debt, but the equity portion has outperformed, your portfolio may now be tilted towards equities. A switch can help restore your desired balance, ensuring your investments remain aligned with your long-term goals.

Take advantage of market conditions

A well-timed switch can help you take advantage of market conditions. For example, if you’re heavily invested in equity mutual funds and the stock market is experiencing a downturn, you may choose to switch to more conservative options like debt or liquid funds. Conversely, during market rallies, you may want to switch funds from safer options to equity funds to maximise returns.

Realign investments with changing goals

Your financial goals may change over time. For instance, if you’re nearing retirement and your investment objective shifts from growth to capital preservation, you may want to switch from equity funds to debt funds or other lower-risk investments. Similarly, if you’re looking to grow wealth aggressively, a switch to higher-risk equity funds might be beneficial.

Switch to lower-cost or direct plans

If you’re currently investing in regular mutual funds through a distributor, you may want to consider switching to direct plans. Direct plans have no intermediary fees and typically offer higher returns compared to regular plans, which charge commissions. By switching to a direct plan, you can potentially improve the overall return on your investment.

Costs of Switching Mutual Funds

Exit loads

Exit loads are charges imposed by mutual funds when you redeem or switch your investment before a specified holding period. The fee is calculated as a percentage of the total value of the investment. For example, if a fund has a 1% exit load and you switch out ₹1,00,000, the cost of the exit load would be ₹1,000.

Capital gains tax

Switching mutual funds is considered a redemption event, which means that any gains made from the investment could be subject to capital gains tax. If you’ve held the investment for less than a year, the gain will be treated as short-term capital gains and taxed at a higher rate (15% for equity funds). If the holding period exceeds one year, long-term capital gains tax applies, which is typically 10% (for equity funds).

Opportunity cost

Each switch may involve an opportunity cost, particularly if you are switching into a fund that doesn’t perform as well as your original choice. While switching can help you align your portfolio with changing market conditions, it’s important to consider whether the new fund will outperform the one you’re switching from.

Read More About Direct vs Regular Mutual Fund

When to Consider a Mutual Fund Switch?

A mutual fund switch can be a strategic move, but it’s important to know when it makes sense. Here are a few scenarios where a switch may be a good option:

Underperformance: If your current fund is consistently underperforming compared to its benchmark or other similar funds, it may be time to consider a switch.
Change in investment goals: As life circumstances change, so might your investment goals. If your risk tolerance decreases or your financial objectives evolve, switching to a more suitable fund can help you align your portfolio accordingly.
Better alternatives: If a new fund with a better track record or lower fees becomes available, switching may allow you to capitalise on these advantages.
Fund manager change: A change in the fund manager can sometimes signal a change in investment strategy or approach. If you are no longer comfortable with the new strategy, switching to a different fund may be an appropriate option.

Is It Better to Switch or Redeem Mutual Funds?

When deciding whether to switch or redeem mutual funds, it’s important to consider your overall investment strategy. A switch involves directly moving from one fund to another, which allows you to keep your investment strategy intact. Redemption, on the other hand, involves selling your investment and potentially incurring taxes before reinvesting the proceeds into a different fund.

Switching is typically the better option if you want to avoid the hassle of redemption and plan to reinvest the amount in another scheme right away.

Mutual Fund Switch Time and Time Frame

The time it takes for a mutual fund switch to be processed can vary. Typically, the mutual fund switch time frame ranges from a few days to a week, depending on the mutual fund house. Online switches are usually faster than manual ones, but it’s important to check with the fund house for specific details.

Conclusion

Switching mutual funds can be a valuable tool for managing your investment portfolio. Whether you’re looking to rebalance your asset allocation, take advantage of market conditions, or switch to a more suitable fund based on your changing goals, understanding how and when to switch can significantly impact your investment success.

Switching wisely, with a clear understanding of the process and its implications, can help you optimise your investment returns and move closer to your financial goals. So, the next time you’re considering making a switch, take a moment to evaluate whether it’s the right move for you.