Do you have mutual funds which were purchased on a deferred services charge (DSC) basis? Investors with such funds may have been told that there are back end fees to sell the investment prior to maturity. With most funds the fees decline each year and are free to sell after 7 years. People who own DSC mutual funds should have a solid understanding of the “switch” options available.
A “switch” is a term is used when making a mutual fund change. The change must be to another fund managed by the same company. Knowing that you can make a change is important for investors to know. It is important to know the types of switches that are available and why a person would make a switch and the types of fees that may or may not apply. It is also important to note that an individual can switch all or a part of a position.
Free and Matured Units
Most mutual fund companies allow unit holders to sell 10 per cent of their position at no cost each calendar year. This is advantageous as it provides some flexibility for investors to rebalance portfolios and to take advantage of other opportunities. Selling the 10 per cent free and matured units may be better done prior to any switches.
When investors purchase a DSC mutual fund they should obtain an understanding of the companies group of funds. Larger fund companies have numerous types of funds with different mandates. Most mutual fund companies permit switches within their “family of funds.”
Types of Fund
Most companies will have the following types of funds: Money Market, Canadian Equity, US Equity, International Equity, Global Equity, Bonds, Balanced, Sector, etc. Many successful investors change the structure of their investments to respond to economic events. Some individuals that fear economic conditions are worsening may want to switch their investments into a money market fund. Others may feel that international investments will surpass Canadian investments in the coming year. Switches allow investors to realign their portfolios.
So Why Change?
You may want to switch funds to achieve rebalancing or to move out of an underperforming fund. A key portfolio manager may have left the company. There may have been a change of style between value and growth investments. You may want to focus on specific sectors, change geographic exposure or change the asset mix
Fund Company Fees
Mutual fund companies generally do not charge for switches. However, if a fund was purchased on a deferred sales charge (DSC) basis with a redemption schedule (typically 7 years), the fund that is switched into must be on the same redemption schedule. Mutual fund companies may levy a fee for short-term trades or inappropriate trades. Generally this may happen only if an individual switches within three to six months. Investors would be wise to inquire if there are any fees prior to switching.
An investment advisor may charge a commission when executing a switch transaction. Not all investment advisors are uniform with respect to whether or not they charge for mutual fund switches. It is important to understand your advisors fee structure and whether they have switch fees.
For people that have mutual funds within their cash accounts it is important to look at the tax consequences prior to making fund switches. In some cases an individual may want to avoid or trigger a capital gain or loss. Switches may be a useful strategy for tax loss selling or for controlling your annualized income. Some investors may have “Class” funds. The purpose of these funds is to allow individuals to switch within other Class funds (note: this is different than the fund family) without triggering a taxable disposition. As a result “Class” funds should be in cash accounts only.
Timing of Switch
If considering a switch at the end of the year with a taxable account you may want to compare the adjusted book cost to the current market value. If you have a significant capital gain, it may benefit you to wait until early January to do the switch in order to defer the capital gain. Investors should be cautious when switching into funds later in the year as they may receive a capital gains distribution on the newly acquired fund from the year’s trading activity.
Switches provide investors more options than they may have previously considered. They can be an excellent way to rearrange your holdings based on your current situation.
This article is for information purposes only. It is recommended that individuals consult with their own tax advisor before acting on any information contained in this article.