During uncertain times, especially now due to the COVID-19 pandemic, even experienced investors may be tempted to switch funds in search of higher returns. However, this short-term response can negatively affect your investment performance over the long term.
The problem that may be experienced by switching funds during a poor performance is that the value of your investment can be affected. The reason this can happen is that in order to switch, you typically have to sell your units, which can lock in the underperformance, which can result in losses.
At the same time, it’s possible that the fund to which you make the switch, won’t be in a position to repeat its impressive past performance at this particular time. Therefore, it can be said that by switching, you’re most likely going to be selling and buying at the wrong time.
Furthermore, switching can also incur fees and taxes. As switching involves the sale of an asset, it’s possible that it could trigger capital gains tax, and the new fund may charge additional fees.
In order to make money if you decide to switch, it’s important to choose the best times to enter and leave the market; this can be very difficult due to movements in the market: they can change daily in response to numerous factors.
The decision to switch can be influenced by the following.
1. Our emotions
During times of underperformance of investments, we tend to be taken over by our emotions and throw out carefully considered investment strategies in favour of switching. Another possible reaction is to change to a very conservative approach and hold back on any investment choices. If you let emotions dictate your decisions, you may permanently affect your investment. It’s essential to keep a level head at all times.
It should be understood that market volatility generally goes hand-in-hand with investing. An investor should typically choose an investment manager they can trust and a unit trust that meets their objectives. In essence, it’s recommended that you don’t base your decision purely on investment performance.
2. Forecasting
Investors looking for new opportunities tend to look at macroeconomic factors, hoping that they will advise whether markets may or may not deliver strong returns. However, numerous studies suggest that there is no connection between share returns and financial growth.
When should you consider switching?
If your objectives change
When you’re young and have few or no dependants, your portfolio may include investments that are more susceptible to market fluctuations such as equities. However, should you get married and/or have a child, you may be more dependent on your investments and switch to funds that can offer more stability.
If you feel your investment manager is underperforming
Effective investment management typically relies primarily on the performance of your fund manager. It’s fair to say that at some point, funds, as well as your investment manager, can go through periods of underperformance. However, if you study the annualised returns on the factsheet (particularly the long-term returns) and your fund seems to be continually underperforming in the long term, it may be best to switch.
If the fund has changed
It’s possible that the fund’s objective may have changed. If the fund no longer meets your original reasons for investing, it may be time to switch.
The bottom line: before you decide to switch you should conduct thorough research, speak to an IFA and think logically so that you can objectively conclude you’re not damaging the value of your investment by switching.
