Cost Of Switching Funds

A friend runs the same play every March. He sells whatever fund lagged last year and buys whatever sits at the top of the one year chart. It feels like good housekeeping. Prune the laggard, back the winner.

I asked him one question. What does the move itself cost, before the new fund has done anything at all.

He had never counted it. So we did.

Say the pot is 11.5 lakh, up from 10 lakh over the year. Redeem inside twelve months and two bills come off on the way out. Capital gains on the 1.5 lakh gain, at 20 percent, is 30,000. The exit load many equity funds charge inside a year, about 1 percent, is another 11,500. That is 41,500 gone. Roughly 3.6 percent of the pot, handed over before the new fund earns a single rupee.

Here is the part that flips the whole thing. Hold the same fund past twelve months and the rate drops to 12.5 percent, and the first 1.25 lakh of gains each year is exempt. The same gain now costs about 3125, and the load has disappeared. The tax code quietly punishes the hop and pays for the hold.

Which resets the question. The new fund cannot be a little better. It has to out-earn the old one by more than the 3.6 percent it just cost you to move, and then keep out-earning it. A one or two point edge does not clear the toll.

The detail most people miss. Inside a fund, the manager's own buying and selling costs you no tax at all. The only trade that ever sends you a bill is the one where you decide to jump. Chasing last year's winner is you volunteering to pay it.

Staying put is not laziness. It is the one free deferral the code hands a fund investor. Make the new fund earn the toll before you pay it.

See your funds lined up on the same footing: