Mutual fund churning: Profitable or not?

When you start your investment journey in the world of mutual funds, getting tempted by multiple strategies to grow wealth is quite natural. More so, when you know your fellow investors are also opting for them. However, not every strategy gives you a positive result.
One such strategy that often tempts investors is mutual fund churning. This refers to the frequent buying and selling of mutual fund units within a short period. Though many investors opine that this can lead to generating relatively better return potential, excessive churning of mutual funds can also incur high costs and lower gains overall. Need more clarity? Well, this article will explain about mutual fund churning, how it functions, when it should be done and its overall impact on investors in India.

• Table of contents

1. Defining mutual fund churning
2. Ways to churn your mutual fund portfolio
3. Right time to churn the mutual fund
4. Effects of churning portfolio on investors
5. Costs associated with mutual fund churning
6. Is mutual fund churning good for long-term benefits?

Defining mutual fund churning

In order to reap the benefits of market fluctuations, investors opt for mutual fund churning, which means they frequently buy and sell units. Though this process can be initiated by investors themselves, a few unethical brokers prefer to initiate it on behalf of the investor to earn higher commissions. While rebalancing a mutual fund portfolio at regular intervals is advisable for better return potential, frequent transactions can lead to unnecessary costs and tax implications. This is why many experts recommend caution while performing mutual fund churning.

Read Also : What is churn rate?

Ways to churn your mutual fund portfolio

• Research about market trends: It is beneficial to study current market conditions in order to identify the sectors or funds with high growth potential.
• Observe fund performance: Before making any hasty decision and making changes to your portfolio, evaluate the past performance of the mutual funds.
• Consider exit loads & taxation: While you may be thinking of earning good returns through your portfolio churning, frequent transactions attract exit loads and capital gains tax.
• Consult a financial expert: Seeking professional advice to ensure that churning aligns with your financial goals is always advisable.

Right time to churn the mutual fund

• Market volatility: When the market undergoes extreme fluctuations, some investors switch funds to mitigate losses.
• Underperforming funds: If a fund consistently underperforms, shifting to a better-performing fund may be beneficial.
• Portfolio rebalancing: Investors realign their portfolios to maintain asset allocation and risk levels.
• Change in financial goals: As personal financial goals change, investors may need to adjust their mutual fund holdings.

Effects of churning portfolio on investors

There are both positive and negative effects of mutual fund churning on investors. Positive because it allows for higher return potential and flexible strategies as market conditions change. And negatives can be that frequent trading comes with higher costs like transaction fees, exit loads and taxes, which can reduce overall returns.

Too much churning can also lead to short-term capital gains, which are taxed at a higher rate than long-term capital gains. Furthermore, frequent trading disrupts compounding, which works well over long periods. Churning may also lead to overtrading, where investors react to short-term market changes instead of sticking to a solid long-term plan, increasing risks and potential losses.

However, churning can be beneficial if done wisely, helping investors rebalance their portfolios and manage risks. But it should align with long-term financial goals to avoid unnecessary risk exposure and potential losses.

Costs associated with mutual fund churning

• Exit load: Many funds charge an exit load if units are sold within a specific period.
• Short-term capital gains tax: In India, equity funds held for less than a year attract a 20% tax on gains.
• Transaction costs: Brokerage fees and other administrative charges add to expenses.

Is mutual fund churning good for long-term benefits?

Whether mutual fund churning is beneficial depends on an investor’s risk tolerance and financial goals. Occasional churning can help with growth, risk management, and seizing market opportunities. However, frequent trading increases costs, taxes and the risk of underperformance.

Read Also: PB ratio: High vs low, which is better for investment?

Conclusion

Mutual fund churning is a risky strategy that often leads to unnecessary costs and lower returns. While strategic adjustments to an investment portfolio are necessary at times, excessive churning can do more harm than good. Always consult a financial advisor before undertaking portfolio churning.

FAQs:

Why do some investors engage in mutual fund churning?

Some investors believe that frequently switching funds can help them maximise profits by capitalising on short-term market movements. However, this often leads to increased costs and lower long-term gains.

How can I identify if my mutual fund investments are being churned?

If you notice frequent buying and selling in your account without a clear long-term strategy, your investments may be subject to churning. High transaction fees and exit loads are also indicators.

What are the potential risks of mutual fund churning?

• Higher costs due to exit loads and brokerage fees
• Increased tax liabilities
• Reduced long-term returns due to the loss of compounding benefits
• Emotional stress from frequent decision-making

Are there regulations against mutual fund churning?

Yes, the Securities and Exchange Board of India (SEBI) has new regulations to curb excessive portfolio churn by distributors seeking higher commissions.

How can I protect myself from mutual fund churning?

• Choose a trusted financial advisor who follows ethical practices.
• Monitor your investment transactions regularly.
• Focus on a long-term investment strategy.
• Be aware of exit loads and tax implications before making changes.

Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.