DEFINITION of Switching
Switching refers to the process of transferring investments. Within the investment market, investor may wish to switch from one fund to another. Investors may also choose to transfer brokerage assets or liquidate a position in exchange for other securities. Often there are numerous costs involved with switching.
BREAKING DOWN Switching
Switching can occur in the investment markets if an investor chooses to transfer invested funds from one investment to another. Many investment companies allow investors to switch their assets to a different share class or to a different fund. Brokerage accounts often incur switching when investors choose to transfer assets from one brokerage to another.
Vanguard provides numerous examples for switching:
1. Vanguard has an exchange policy and reports that all open Vanguard funds accept exchange requests.
2. One example of switching among fund share classes includes Vanguard’s admiral versus investor shares. Investors in an investor share fund can convert to admiral shares if eligible to take advantage of lower costs.
3. Similar to many brokerage accounts, Vanguard allows for in kind brokerage account transfers. In kind transfers typically do not incur costs. Stocks, bonds and investment funds are commonly available for in kind transfers.
Generally switching or exchanging fund shares within an investment company is acceptable. The Securities and Exchange Commission reports on switching in their “Mutual Funds and ETFs Guide.” Some funds offer exchange privileges whereby shareholders can transfer their investment from one fund to another. Fund exchange policies are discussed in a fund’s prospectus. Customer service representative can also provide details on an investment company’s fund exchanging policies. A fund exchange with no transfer fees will still be responsible for differences in price among the funds involved. An investor will incur a capital gain if they exchange into a fund with a lower value. An investor exchanging into a fund with a higher value will be required to cover the difference. Investors should closely monitor all conversions for tax reporting requirements and documentation.
Switching Costs and Considerations
Switching or exchanging among different investments can incur various costs. Some costs may be psychological or time-based.
Liquidating and reinvesting incurs the highest switching costs. When investors seek to switch securities to a non-transferable investment, they must liquidate and essentially use the cash received from the liquidation of their initial securities to purchase new securities. This process can involve significant commissions when selling and buying securities. Investors may choose to do this if prospects for growth, yields or capital gains or higher in another investment.
Transferring assets from one provider to another typically involves extensive paperwork, holding periods and illiquid assets during the time of transfer. Switching to new funds can also result in new fund reporting, new types of tax reporting and various other reporting considerations.
Investors are advised to undergo thorough due diligence when investing in investment securities to avoid switching costs. If an investor expects switching among their investment assets to be an overall need, it is suggested that they work with an investment company which accommodates exchanging to minimize costs.