When should you switch from stocks to mutual funds?

One of the basics of wise investing is to be flexible. This is because flexible investors can mould themselves as per the winds of change and ensure their investment strategy stays on track. Most beginners start their investment journey with stocks as it is thrilling, instant and promises high returns. However, as new investors attain investment maturity, they may realise newer priorities and responsibilities – leading to the necessity of a more balanced and stable approach.

This is where switching to mutual funds come into the picture.

Now, you must be having a lot of questions such as how to switch, should you be making this leap all at once or spread it over time or when is the right time to switch? This article will answer your dilemmas. It will take you through the fundamentals of stocks and mutual funds, when to switch, whether market conditions are favourable for mutual funds, tax implications and much more.

• Table of contents

• Stocks vs Mutual Funds
• Signs it's time to switch from stocks to mutual funds
• Market conditions that favour mutual funds over stocks
• Investment goals and risk appetite: When mutual funds
• Tax implications of switching from stocks to mutual funds
• Tax implication during switching from stocks to mutual funds
• How to transition your portfolio from stocks to mutual funds

Stocks vs Mutual Funds

Ownership and control

• Stocks: When you buy a stock, you own a piece of the company. You have full control over which company to invest in and when to sell or buy.
• Mutual funds: These are professionally managed pools of money. Fund managers make investment decisions on your behalf and you own units of the fund, not the company directly.

Risk level

• Stocks: Undoubtedly stocks have higher risk, especially if you're investing in fewer stocks or don’t track the market closely.
• Mutual funds: Your investment is spread across multiple assets such as stocks, bonds etc. which mitigates risk.

Required knowledge and time

• Stocks: Requires regular monitoring, research and market knowledge.
• Mutual funds: Easier for people who can’t dedicate time or don’t have deep market knowledge.

Investment cost

• Stocks: Lower expense ratio, but brokerage and transaction charges can apply frequently.
• Mutual funds: Comes with an expense ratio but includes professional management.

Return expectations

• Stocks: Higher returns come with higher volatility and this is what stocks offer.
• Mutual funds: Though returns are moderate, they are more stable in the long run.

Signs it's time to switch from stocks to mutual funds

Market tracking is challenging

Not everyone can monitor the market minute-by-minute. If you are too busy, missing market news or failing to track stock performance, switching to mutual funds might be a wise choice.

Uncomfortable with high risk

There is no doubt about this that stock markets can be extremely volatile. If the ups and downs are bothering you, it’s a clear sign that mutual funds, especially debt or balanced ones, can be a suitable choice for you.

Poor stock selection

If you are unable to choose the right stock due to lack of research, emotional decision-making or poor timing then it is a sign to handover your investment to a professionally trained advisor. A mutual fund managed by an experienced professional might handle and grow your wealth relatively better.

Read Also: Mutual Funds vs Stocks: Differences and Which is Better?

Market conditions that favour mutual funds over stocks

During high volatility

There are several factors that impact the financial market. These factors include political events, economic slowdowns, or global issues. Mutual funds can help balance out the uncertainty in the market better than stocks.

Markets downturn

When the market is consistently falling, mutual fund managers can rebalance the portfolio and move some assets into relatively stable options, something individual investors may struggle with.

Impacts on specific sectors

Suppose you have invested in the automobile sector and the sector due to a pandemic takes a heavy hit. A diversified mutual fund won’t be as severely affected in this scenario and the losses can be balanced out.

Investment goals and risk appetite: When mutual funds make sense

Long-term goals

If your goals are long-term like retirement, children's higher education or buying a house, then mutual funds can be suitable for you. You can choose funds based on your time horizon and risk profile.

Low-risk appetite

If you are someone who gets anxious with even a slight dip in your stock prices then it would be better for you to avoid direct stock investing. Rather invest in mutual funds for diversification and mitigated risk.

Tax implications of switching from stocks to mutual funds

Stocks taxation

When you sell stocks, profits are taxed.

If you sell after holding for more than 1 year (Long-Term Capital Gains), it’s taxed at 12.5% if the profit exceeds Rs. 1.25 lakh per year.

For less than 1 year (Short-Term Capital Gains), it's taxed at 20%.

Mutual fund taxation

• Equity funds: Same tax rules as stocks.
• Debt funds: Gains from debt funds are taxed as per your slab

Tax implication during switching from stocks to mutual funds

Before you switch from direct stock ownership to mutual fund investment, you must sell your stocks. Then, the capital gains arising from sale of stocks will be taxed under the applicable LTCG and STCG rules for equities. Post taxation, you can route the proceeds into a mutual fund scheme of your choice.

Read Also: Stock SIP vs Mutual Fund SIP: Key Differences and Which is Better?

How to transition your portfolio from stocks to mutual funds

Review your current portfolio

You would need to invest some time in reviewing your current portfolio. Check which of the existing stocks are underperforming and which ones don’t fit your future goals.

Sell strategically

Avoid selling all your stocks at once. Spread your sell orders over time to avoid heavy tax or sudden loss during a bad market phase.

Start with SIPs

SIPs can be a suitable investment option for beginners. You don’t have to put everything into mutual funds in one go. Start with small monthly SIPs. This also helps you average the cost.

Choose a suitable type of fund

You must know that equity funds are for growth. Debt funds are for stability and balanced funds are for moderate risk. Index funds offer low-cost, passive investing and ELSS offers tax saving.

Conclusion

Switching from stocks to mutual funds isn’t rocket science but it requires due consideration to avoid mistakes. While direct stocks offer control and reasonable returns, they come with higher stress and risk. Mutual funds, on the other hand, provide simplicity, stability and professional management.

FAQs:

How do I know if it's the right time to switch from stocks to mutual funds?

If you find managing stocks stressful, don’t have the time to keep track or keep making losses, it’s a good signal to consider mutual funds. Also, if you're nearing a financial goal, shifting to more stable options makes sense.

Will I lose money when transitioning from stocks to mutual funds?

Not necessarily, but you will have to pay the relevant STCG or LTCG tax (if applicable) before you can transition to a suitable mutual fund scheme.

Are mutual funds less risky than stocks?

Generally, yes. Mutual funds diversify across sectors and assets, so the risk is spread out. Stocks are riskier as they depend on the performance of one company.

What are the tax implications of switching from stocks to mutual funds?

Selling stocks triggers capital gains tax. Investing in mutual funds doesn’t have an immediate tax impact, but you’ll be taxed when you redeem them. The type of mutual fund (equity or debt) determines how much tax you pay.

Can I invest in both stocks and mutual funds simultaneously?

Absolutely. Many investors do that. It’s about balancing your portfolio. You can use mutual funds for relative stability and stocks for aggressive growth. Just ensure your asset allocation suits your goals and risk tolerance.