Switching Mutual Funds – Five Things To Know Beforehand

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Mutual funds are a popular investment and a great tool for wealth creation. As a mutual fund investor, there are various strategies you can explore to maximise your returns. One such strategy is switching, which refers to selling mutual fund units of a particular scheme and using those proceeds to buy units of another scheme. It is a two-step transactional process where selling is followed by purchasing

Switching, though convenient and effective for managing investments, must first be understood before being used. Here is a quick guide highlighting some important aspects of switching you must know about.

  1. Types of switching

The first type of switching happens within schemes of the same mutual fund house. This involves selling units of a scheme, the proceeds of which are then automatically invested in another scheme of the same fund house. The fund house uses the funds on your behalf to purchase units in the new scheme. In this case, the proceeds are not credited to your bank account.

The second type of switch involves two different fund houses. Here, units of a scheme by one fund house are sold, and its proceeds are credited to your linked bank account. You can then purchase units in the new scheme with a different fund house by transferring funds available in your bank account.

  1. Switching fees & charges

Switching involves selling and buying transactions, which usually involve certain charges. An exit load, usually 1% of the fund value, is applicable on units that are sold without completing a specific holding period. After this charge is deducted, the balance is either reinvested in a scheme of your choice (for inter-switching transactions) or credited to your bank account (for intra-switching transactions).

When reinvesting in a new scheme, charges such as stamp duty, cess and fund management fees may have to be paid by the investor. After these charges are deducted, the remaining balance is invested in the new scheme.

  1. Partial or full switch

There are multiple options available for switching mutual fund schemes. You may sell all your units in one go, sell them in tranches, or sell a portion of the units while retaining the rest in the source scheme. It is not mandatory to sell all your existing units when switching. You can decide how many units you want to sell based on your requirement and portfolio restructuring goals.

  1. Lock-in period

Some mutual fund schemes may have a lock-in period which can affect the switch. For instance, tax-saver funds have a lock-in of 3 years. This means that units of such a scheme cannot be sold and/or switched until they have completed the 3-year holding period.

  1. Tax implications

Switching involves redeeming investments. Thus, the applicable tax must be paid on the gains recorded from such investments. Mutual fund units incur short- or long-term capital gains tax depending on their holding period. A 10% long-term capital gain (LTCG) tax is levied if units are held for over one year before being sold. However, if units are sold within a year of purchase, a 15% short-term capital gain (STCG) tax will be applicable.

When switching from a debt fund, a capital gains tax of 20%, after indexation, is applicable. For a short term of under three years, the investor must pay the applicable capital gains tax based on their income tax slab rate.

The switching strategy can help you restructure your portfolio to align with your financial needs or market cycles. For instance, when you retire, you can switch your higher-risk equity investments to lower-risk investments such as debt. Before switching your funds, outline the objectives you want to achieve with it, and understand the implications involved, to make an informed decision.

The writer is CEO, BankBazaar.com – India’s largest fintech co-brand credit card issuer.