The Trouble with Switching Funds in Response to Short-Term Market Conditions

During periods of underperformance, even the most experienced investors get tempted to switch funds in search of better returns. However, switching funds in response to short-term market conditions can jinx your investment success over the long term. Mthobisi Mthimkhulu explains.

After a flat few years, 2018 was particularly difficult for local investors in South Africa, with the FTSE/JSE All Share Index returning -8.5%. To add to the woe, price declines in other asset classes contributed to overall negative performance.

During these periods, like many other investors, you may get tempted to switch out of a fund that is doing poorly and buy into another fund that is doing relatively better. While this may appear to be a sensible way to protect your investment, or generate better returns, switching funds during poor performance inevitably destroys the value of your investment. This is because, in order to switch, you have to sell your units, which often locks in the underperformance of the fund you are switching out of. At the same time, the fund that you switch to may not be positioned to repeat its good performance of the past in the future. In effect, by switching you are often selling and buying at exactly the wrong time.

Switching could also cost you in fees and taxes. As switching involves the sale of an asset, the transaction could trigger capital gains tax. In addition, the fund you are switching to may charge initial fees.

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