When you invest in mutual funds, you can change investment strategies. At times, the fund of your choice might perform unsatisfactorily, or you may come across a comparatively better scheme. In such situations, you can move your money fully or partially from one mutual fund scheme to another. This process is known as switching.
But is it a good idea to switch mutual funds? Read on.
What happens when you switch mutual funds?
You can switch mutual funds by selling units of the current mutual fund and purchasing units under a new fund. When you sell any mutual fund units, you will have to pay taxes on short-term or long-term capital gains. You will also have to pay an exit load fee to your fund house, which is a percentage of your Net Asset Value (NAV). Note that the taxation process is different for debt and equity funds.
- Switching from equity funds: If you want to switch from equity funds within a year of investing, you will have to pay short-term capital gains tax (STCG) at 15%. After one year, you will have to pay long-term capital gains tax (LTCG) at 10%
- Switching from debt funds: In the case of debt mutual funds, your capital gains are short-term if your holding period is less than three years. These gains are then added to your net taxable income and taxed at your income tax slab rate. If your holding period is longer than three years, you will have to pay a 20% LTCG.
Additional Read: How Debt Mutual Funds Benefit in your Portfolio
Should you switch to a high-performing mutual fund?
When the mutual fund schemes in your portfolio are giving low returns, you might feel the temptation to switch. You may think that it is better to invest in the ones recording higher returns at the time.
When facing this dilemma, remember that you picked that particular scheme with a purpose and a period in mind. Short-term underperformance should not be your reason for exiting a mutual fund scheme. At the same, if the fund performance has been consistently mediocre than its peers, or you’re looking for an asset rebalance, switching could be a convenient option.
Should you switch to an NFO?
Sometimes, you might come across new fund offers (NFO) from certain asset management companies. NFOs often create a buzz among investors, and many people consider switching, especially if their fund has been underperforming for a considerable period of time. However, investing in an NFO just because of novelty is not a prudent decision.
The decision to invest in a particular mutual fund should be based on your suitability. Before picking a scheme, observe its past track record and assess its performance during different market conditions. If an NFO offers you something that wasn’t previously available to investors, you can reconsider, understand, and come to a decision.
Additional Read: Is it Necessary to Revise Your Financial Plan?
A word of advice
Before switching, you must remember exit load charges and tax implications. The decision of switching should never be a rushed one. It is best to keep your funds invested and give them ample time to perform.
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