Often, our investments are not just about their long-term benefits. They also serve our short-term or immediate needs. In an investor’s life, several unforeseen expenses or investment opportunities may also emerge which requires immediate funds. While investors are well-versed with the process of investing in mutual funds, most are not aware how or when to sell or redeem their investments in mutual funds.
Listed below are certain critical factors you need to understand before you plan to sell your investments in mutual funds:
Timing the market
Inexperienced investors worry about the possibility of a fall in the stock markets. They forget that volatility is second nature to the stock market. Very few investors can get the timing of entry and exit in stock markets right.
When volatility works in investors’ favour—meaning when markets go up—it gives rise to opportunities of making extraordinary returns. In a falling market, however, many investors lose their confidence in equities and sell their investments at whatever price they get.
Savvy investors do not try to time the market. They invest at regular intervals and prefer to stay invested for a long period of time. They buy units of mutual funds at different price points. This strategy brings down their overall cost of investments in mutual funds. This helps them accumulate a large corpus and could enhance their profits when markets rebound from a fall. Hence, think twice before redeeming your mutual fund units only because the markets are falling.
Switching from underperformers
It is natural that investors look for units of the best-performing equity mutual funds. However, it is not often that all schemes that you are invested in will be top performers. Sometimes, the schemes we choose to invest in, perform poorly. These are the times you should be careful. Instead of exiting from such schemes in a hurry, it is important to analyse the reason for its underperformance. The scheme you have invested in may have different benchmarks and different investment styles compared to that of the best-performing schemes. The returns generated by a scheme depend on these two factors.
Investors must ensure they compare their scheme’s performance with the benchmark of the scheme and with other peer schemes that have a similar benchmark or fall in the same category. Savvy investors do not sell a scheme just because it has underperformed for a quarter or two. Some strategies take time to deliver returns. Savvy investors exit schemes only after giving enough time to the fund manager to perform.
Financial goals
The financial goals of an individual also dictate investments. During youth, for instance, one can allocate a large chunk of money to equity mutual funds if one is saving for retirement. However, as one grows older and nears retirement age, it is advisable to gradually shift to relatively stable asset classes like fixed income. To counter the risk of a sudden fall in the markets when one is a few years away from retirement, one could shift money invested in units of equity mutual funds to bonds or bond funds. Here, in this process of securing money for his financial goals, the switch—redeeming the units of one scheme and buying units of another—is justified.
Asset allocation & asset rebalancing
When an investor saves and invests money in line with her asset allocation, she has a clearly defined mix of equity, debt and gold in her mind. However, markets are dynamic. Prices change almost every day and each asset class moves in a distinct manner. This means investors’ asset allocation also changes over six to twelve months. It thus, becomes necessary to rebalance the asset allocation. In such a situation, an investor sells that asset class which has appreciated to such an extent that it has exceeded investors’ estimates and buys those asset classes which have not performed as much. Investors may redeem some of their units of the mutual funds while rebalancing their portfolio.
Scheme-specific changes
It is often observed that the scheme in which you are invested announces sudden changes. These changes could be a change in the fund manager, change in the fundamental attribute such as investment objective or risk matrix of the scheme.
When a fund manager changes, investors keep a track of the performance of the scheme. Savvy investors do not exit investments in a hurry when the scheme’s fund manager changes. Many mutual fund houses have succession planning in place and one fund manager’s exit does not pull the scheme’s performance down. Smart investors sell units of a mutual fund scheme only when they see the performance being impacted for a few quarters. Change of fund manager, however, counts a lot in case of small cap funds, where the fund manager’s role in stock selection is far more important.
In case of change in fundamental attribute of a scheme, the fund house issues a notice to all unit holders. The unit holders are given a window of zero exit load for a period of one month. Though it is not mandatory to exit such a scheme during this window, investors use the time given to analyse the changes and make an informed decision. If the change in investment policy is going to change the returns of the scheme in an adverse manner, then a large number of experienced investors exit the scheme.
Tax liability
Though there may be a valid reason to redeem units of a mutual fund, investors should take into account the tax liability as well.
In case of equity funds, gains on sale of units held for more than one year are taxed at 10 percent, if the gains in a financial year exceed Rs 1 lakh. Gains below Rs 1 lakh on units held for more than a year are tax-free. However, any gains on units held for less than one year are taxed at 15 percent.
In case of non-equity funds, gains on sale of units held for more than three years are taxed at 20 percent rate of tax post indexation. If units are redeemed before three years, gains are added to the income of the investors and taxed at the applicable income tax rate.
Investors must keep tax liability in mind while redeeming the units of mutual funds held.
Exit load
Exit load is charged to discourage short-term investments in units of mutual funds schemes. They are expressed in percentage terms and for a specified period of time. For example, a scheme may charge an exit load of 0.5 percent if its units are sold within three months from the date of allotment. While selling units of mutual funds’ schemes, investors should check if they come under the exit load period. Selling in the exit load period brings down the returns of investors.
Thus, while it is essential to do your research when investing in mutual funds; it is equally essential to study the above factors before redemption. This will ensure that you exit from your investments having made a profit, not a loss.