 "Understanding switching costs in MF plans to avoid unnecessary expenses")
Mutual fund investors often overlook a critical aspect that can significantly impact their investment returns: switching costs. Understanding these costs becomes essential for making better financial decisions.
What is a switch in mutual funds?
Switching in mutual funds refers to transferring your investment, either partially or fully, from one scheme to another within the same fund house. Alternatively, you can move your money between two funds of different fund houses, a process referred to as switch-in and switch-out. In such cases, you will need to redeem your investment from one fund and reinvest it in another, which may incur an exit load and tax on capital gains.
Also Read
You also have the option to switch from regular plans to direct plans within the same fund. Regular plans include distributor commissions, whereas direct plans do not, which lowers your overall investment expenses. However, managing investments in direct plans requires your active involvement.
Benefits of switching mutual funds
Asset rebalancing
Over time, the performance of various asset classes, such as equities, bonds, and cash, can shift. Asset rebalancing allows you to adjust your portfolio to maintain a specific allocation that aligns with your financial goals and risk tolerance.
Taking advantage of market conditions
Switching funds strategically can help you capitalise on market trends. For example, during a stock market downturn, you might shift from equity mutual funds to conservative options like debt or liquid funds. Conversely, in a market rally, switching from safer funds to equity-focused funds could maximise your returns.
Realigning investments with changing goals
As your financial goals evolve, your investment strategy may need adjustments. For example, nearing retirement, you might prioritise capital preservation over growth and switch from equity funds to debt or lower-risk investments. On the other hand, if you aim for aggressive wealth creation, switching to higher-risk equity funds might be more suitable.
Switching to lower-cost or direct plans
If you are currently invested in regular mutual funds through a distributor, switching to direct plans can be beneficial. Direct plans eliminate intermediary fees and generally offer higher returns since they don’t include commission charges. By opting for direct plans, you can reduce investment costs and enhance your overall returns.
“Before you should start switching mutual funds, you should define the purpose for making the change. For example, if you are looking to rebalance, align with financial goals, or improve performance etc. This clarity will ensure that you do not take impulsive decisions and switch based on that. Switching costs include exit loads and capital gains taxes, which significantly impacts your returns. The exit load ranges between 0–2 per cent for equity funds held for less than a year for equity mutual funds and short-term capital gains tax is levied at 20 per cent, while long-term capital gains above Rs 1.25 lakh are taxed at 12.5 per cent. Thus, if you are not mindful then you may end up incurring expenses unnecessarily,” said Nabanita Dutta, MF Analyst, Anand Rathi Wealth.