Investors are always told that equity mutual funds are a great way to save towards their long term goals. However even if using a systematic investment plan (SIP), these are not risk free investments and you can’t trust your mutual funds investments to pay out all the time. In line with this, many seasoned mutual fund investors often change the funds they are making contributions towards for several reasons. The most common reasons are improper management and poor performance of the fund, extending beyond the 4 year benchmark when you would have expected things to become steady. Apart from this you may also be investing in too many funds, and want to consolidate your investments. But just as important as it is to recognise when you might want to change the funds you invest in, is the need for a coherent mechanism to execute that decision effectively. 

Most investors choose to make contributions through an SIP, in order to mitigate risks associated with their investment; instead of making lump sum contributions. So what do you do when you realise that your SIP might not be working out and you want to switch? More often than not, the first thing people are tempted to do is, stop their current SIP and draw out all the funds, by placing a redemption request for the entire amount invested. Then once they receive the funds, they make a lump sum investment into the new fund selected, then continue contributing through and SIP. 

This may not cause too many issues if you have  just started investing and your accumulated investment is not significant. However, if you SIP has been going on for quite a while, and a significant amount has been accumulated, it is an extremely inefficient way to go about the process.

Why shouldn’t I draw out my funds from my old SIP before starting a new one?

Suppose you have been investing for a period of years with a significant SIP amount then you might face some setbacks, in the form of transaction costs, if you choose to draw out your funds before investing in a new scheme.

1. Capital gains tax: If your funds exceed 1 lakh then they will be subjected to a capital gains tax. Short term capital gains tax – for a period of less than one year – is 15%, while long term capital gains are taxed at 10%. 
2. Market volatility: The equity market is particularly volatile in the short term. Since the process of drawing out your funds and then reinvesting them is not spontaneous, you could incur losses in the intermediate period if there are significant changes in the market.
3. Significant exit load: Exit load is the cost an investor pays if they sell their mutual fund units before the maturation period that you have defined. The amount you pay for leaving a scheme early can change depending on the time at which you pull out your funds, and the company you have invested through.

How should I go about changing funds?

While changing mutual funds you should try mitigating transaction costs as much as possible. Here are some tips to help you with that:

• Don’t combine leaving an old fund with starting a new one. This need not be a linear process. Start making SIP contributions in the replacement fund before you exit the old fund. This can help you counteract market volatility.
• Assess the capital gains tax you may incur and the exit load you may face by leaving the old fund. While the exit load may be non-negotiable, you can reduce any capital gains you face by moving out your money over multiple iterations.
• In some cases, your old fund might start doing better. Drawing your money out over a period of time also gives you the choice of wanting to maintain a stake in the old fund as well, in the event of such changes. 

Go over these points the next time you decide to change funds, and remember to always start an SIP in the replacement fund first. Finally, consult a professional financial advisor when it comes to deciding on mutual funds. Their expertise can help you save a lot of time, effort and money!