The reasons can be many. For most, it is about lack of performance over a decent period of time (3-4 years of below benchmark performance). For others, the fund was a hasty and uninformed decision taken because of what a market pundit said. It could also be that you simply have way too many funds and want to consolidate your portfolio.
So what do you do?
This will depend on how you invest. We are assuming that your investments are aligned to your objective and you are doing your due diligence when you have selected the new fund you would like to invest in instead.
If you are a SIP investor you might be tempted to do something like the following:
1) Stop existing SIP in the fund to be replaced.
2) Place redemption request for the entire amount invested.
3) Wait for the money to arrive at your bank.
4) Invest entire proceeds into the replacement fund.
5) Start SIP in the new fund.
The above process is actually not incorrect if you had just started investing and your accumulated investment is not significant.
Time out of the market – The time between withdrawal and re-investment in the new fund. There is a chance that there might be a significant market movement that you might miss out on during the intervening period.
There’s a problem here though if you have been investing for a while
If, however, you had been investing for a period of years with a significant SIP amount then you would face 3 challenges:
1) Taxes – Even if you withdraw your equity funds after 1 year, you are subject to 10% of your gains getting taxed if they exceed 1 lakh (Long Term Capital Gains Tax). It is 15% tax if you withdraw within a year.
2) Exit Load – Most equity funds don’t have an exit load beyond a year but some have up to two years.
3) Time out of the market – The time between withdrawal and re-investment in the new fund. There is a chance that there might be a significant market movement that you might miss out on during the intervening period.
The above challenges collectively can be considered as “transaction cost” associated with moving your holdings. This can be substantial if you don’t plan your move smartly.
What is the alternative?
You need to start with something that has no transaction cost. That is simply starting a new SIP in the fund you intend to move to eventually and stopping your earlier SIP in the old fund.
This move ensures that you are starting in the better fund and your future investments are aligned to your new selection.
What about my existing holding in the old fund?
Moving all at once is not a great idea. Instead:
1) Assess your capital gains and exit load
2) Spread your movement of money from the old fund to the new over a period of time.
We recommend reviewing your portfolio every quarter and taking this decision. There is no doubt that even then, it is not a simple task. Scripbox automates this for our investors using an algorithm.
Delink getting started in a new fund from exiting an old fund.
When trying to switch out of investments, keep the total transaction costs in mind.