Switching

What Is Switching?

Switching generally refers to the process of transferring or changing investments. Investors may decide to move investment money between different funds, transfer their brokerage account to a different broker, or sell their securities in exchange for different securities. Depending on the process you choose, there are sometimes costs associated with switching.

How Switching Works

Switching occurs when an investor decides to transfer money from one investment to another. Many investment companies allow investors to move their assets to a different share class or to a different fund and it can sometimes make sense to take up this option when needs or circumstances change.

Funds

The exchange policies of every fund are discussed in a fund's prospectus. Some funds offer exchange privileges that allow shareholders to transfer their investments from one fund to another without a fee. However, even if an exchange does not incur a fee, the investor will still be responsible for any differences in prices between the funds involved.

For example, an investor exchanging into a fund with a higher value will be required to cover the difference, while an investor exchanging into a fund with a lower value will incur a capital gain. As a result, investors should closely monitor all conversions for tax reporting requirements and documentation.

Brokerage Account

Investors may also engage in switching when they transfer their assets from one brokerage account to another. There are several reasons why investors may decide to change brokers, including to save on fees, gain access to wider research, or to tap into the robo-advisor algorithms available on some platforms.

Most firms allow for in-kind brokerage account transfers, enabling customers to move existing investments directly from one broker to another without first having to sell investments and then transfer the cash proceeds. In-kind transfers typically do not incur costs.

Drawbacks of Switching

The process of transferring investments can have high costs associated with it, including time. When an investor seeks to exchange securities for a non-transferable investment, they must first liquidate their position and then reinvest, essentially using the cash received from the liquidation of their initial securities to purchase the new securities.

This scenario incurs the highest costs because of the commission fees required when buying and selling securities. Although this process may be expensive, investors may choose to proceed with paying the fees if the prospects are higher for growth or capital gains in another investment.

Transferring investments from one broker to another typically involves extensive paperwork, holding periods, and, during the time of transfer, all assets becoming illiquid. Switching to new funds, meanwhile, can result in additional reporting consideration, including additional tax reporting.

The Bottom Line

In order to minimize the financial and time costs of switching, investors should perform their due diligence. Often, the best course of action is to work with an investment company that accommodates any switching needs free of charge.