What Is Switching?

In general, switching refers to the process of transferring or changing investments or investment strategy. 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.

Key Takeaways

  • Switching is when an individual or organization changes up their investments.
  • This process can involve moving money between mutual funds of different strategies, changing to different share classes, or reallocating a portfolio to a different mandate.
  • Switching may also refer to moving an investment portfolio from one broker to another.

How Switching Works

Switching occurs when an investor decides to transfer funds from one investment to another. Many investment companies allow investors to move their assets to a different share class or to a different fund. 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. 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.

Investors may also engage in switching when they transfer their assets from one brokerage account to another. Investors may decide to change brokers for different reasons. Most firms allow for in-kind brokerage account transfers. An in-kind transfer allows you to move your existing investments directly from one broker to another broker, without first having to sell your 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 is seeking 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 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 will be illiquid. Switching to new funds can also 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, perhaps working with an investment company that accommodates any switching needs in order to minimize costs.