What is Mutual Fund Switching and How to Switch

There are times when you may feel the need to switch from one mutual fund scheme to another, or from a regular plan to a direct plan, to achieve your financial goals.

One thing to remember is, switching between mutual schemes is only possible withing the schemes of the same AMC or fund house. Also, switching mutual funds is not a difficult process, it involves certain factors, rules, charges, and tax implications that you should be aware of.

What is a mutual funds switch?

Mutual fund switching refers to transitioning between debt and equity funds or from regular to direct mutual fund plans to manage risk or enhance returns. Essentially, it involves moving from one mutual fund scheme to another when the current scheme underperforms. This option is commonly chosen by investors dissatisfied with their fund's performance. Additionally, investors can switch between fund houses, necessitating the redemption of units from the current house and purchasing units from the new one. However, this process incurs exit loads and capital gains payments.

Benefits of switching in mutual funds

Experts suggest that mutual fund switching enhances asset allocation by allowing investors to reallocate funds within or between funds, effectively reducing liability associated with underperforming assets. This strategy offers several advantages:

1. Enhanced performance: Investors can switch from underperforming assets to higher-performing ones, utilising metrics like CAGR and XIRR to gauge asset growth and identify long-term investments for optimal returns on maturity.

2. Convenient digitisation: Digital platforms facilitate seamless mutual fund switching, enabling investors to initiate switches online and directly transfer funds between schemes with ease.

Factors to consider before switching in mutual funds

• The reason for switching: You should have a clear and valid reason for switching mutual funds, such as change in your risk profile, investment objective, time horizon, or fund performance. Switching mutual funds without a proper reason can hamper your long-term returns and increase your costs.
• The exit load and capital gains tax: When you switch from one mutual fund scheme to another, or from a regular plan to a direct plan, it is considered as a redemption and a fresh investment. Therefore, you may have to pay an exit load, which is a percentage of the Net Asset Value (NAV) deducted by the fund house if you exit before a specified period. You may also have to pay capital gains tax on the profits you make from the switch, depending on the type and duration of the fund.
• The suitability of the new fund: You should do a thorough research on the new fund that you want to switch to, and check its past performance, risk-return profile, expense ratio, portfolio composition, fund manager’s track record, and consistency. You should also compare it with other similar funds in the category, and ensure that it matches your risk appetite, investment objective, and time horizon.

How to switch mutual funds

Switching mutual funds can be done in two ways: online or offline. Here is what to do for both cases:

• Online: You can switch mutual funds online by logging in to your mutual fund account, either through the fund house’s website or a third-party platform like the one provided by Bajaj Finserv. You can then go to the transaction page, where you can buy, sell, or switch mutual fund units. You can select the ‘switch’ option and choose the fund name and the plan that you want to switch to. You can then follow the instructions on the screen and complete the switch. It may take up to four working days for the switch to reflect in your account statement.

• Offline: You can also switch mutual funds offline by visiting the nearest branch of the fund house and filling and submitting a switch form. You will have to provide details such as your folio number, fund name, plan, and option that you want to switch from and to. You can also get this done through your intermediary, such as a distributor, agent, or broker.

Tax implications of switching between mutual funds

Switching between mutual funds is a taxable event, as it is considered as a redemption and a fresh investment. The tax liability depends on the type and duration of the fund that you switch from and to.

Here are the tax rates applicable for different types of funds:

• Equity funds: These are funds that invest at least 65% of their assets in equity and equity-related instruments. If you switch from an equity fund before one year, you will have to pay short-term capital gains tax at 15%. If you switch after one year, you will have to pay long-term capital gains tax at 10% on the gains exceeding Rs. 1 lakh in a financial year. You will also have to pay securities transaction tax (STT) at 0.001% on the redemption value of the equity-oriented fund.
• Debt funds: These are funds that invest predominantly in debt and money market instruments. If you switch from a debt fund before three years, you will have to pay short-term capital gains tax as per your income tax slab. If you switch after three years, you will have to pay long-term capital gains tax at 20% with indexation benefit, which adjusts the cost of acquisition of the fund units as per the inflation rate.
• Hybrid funds: These are funds that invest in a mix of equity and debt instruments. The tax treatment of hybrid funds depends on their asset allocation. If the fund invests more than 65% in equity, it is treated as an equity fund for tax purposes. If the fund invests less than 65% in equity, it is treated as a debt fund for tax purposes.

When can you switch mutual funds?

You may consider switching mutual funds under the following conditions:

• If your financial objectives shift.
• If your current mutual fund may underperform.
• If you want to opt for a different asset category.
• If you want to switch from a regular to a direct mutual fund plan.
• If you might contemplate moving to a different asset management company (AMC)

Rules for switching mutual funds

Here are some guidelines to consider before proceeding with a mutual fund switch:

1. Determine switch type: Decide whether to switch within the same scheme or to a different one.

2. Check requirements: Ensure you meet the minimum investment criteria for intra-scheme switches.

3. Prepare for costs: Be ready for potential exit loads and capital gains taxes.

4. Initiate inter-scheme switch: Sell your current fund and apply for redemption.

5. Tax consideration: Understand that mutual fund capital gains are taxed, with short-term gains at 15% and long-term gains at 10%.

6. Account for lock-in periods: Note any lock-in periods, such as the three-year lock-in for Equity Linked Savings Schemes, which restricts switching before completion.

Conclusion

Switching mutual funds can be a smart move if done for the right reasons and at the right time. However, investors should be careful about the exit load, capital gains tax, and suitability of the new fund before making the switch.

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