Mutual Funds

When Is A Good Time To Exit Your Mutual Fund Investment? – Forbes Advisor INDIA

When it comes to mutual funds, diligent investors can find plenty of information in the public domain that can help them make their investment decisions. There is information on how to invest, when to invest, which funds to choose, how to choose funds, the risk involved in mutual funds and much more. However, there’s not much to be found on exit strategies for mutual funds, typically making this the biggest challenge for investors. Having conviction around an exit strategy becomes especially relevant whenever markets are correct; without it, investors panic and exit based on sentiment rather than a well-planned strategy. 

Many times investors try to time the markets by exiting their investments with a hope to re-invest at lower levels. This is a classic case of “market timing”. Also, at times, investors tend to treat mutual funds like stocks. A stock can be underpriced or overpriced and hence, there could be a case to exit an expensive stock vis a vis a mutual fund. A mutual fund, on the other hand, is a basket of investment products and the price of each unit reflects the value of the products in the basket. Hence, the question of over-valuation or under-valuation does not arise.

Knowing how to exit from a mutual fund is as important as knowing when to exit and can make or break your wealth building process. Exiting from a fund should not be done based on market swings, except in case of emergencies. One must do it thoughtfully, with a plan of action. 

Here are a few instances when an investor should consider exiting from the scheme. 

1. Achieved or Nearing Financial Goals? Exit from the Scheme and Invest in Less Risky Assets

When you are nearing your financial goal sooner than expected, your focus should be on preserving the corpus. When you are nearing your goal, your ability to take risks reduces. Remaining invested in an equity fund once the goal is reached could be counterproductive at times. 

If you have achieved your financial goal earlier than planned, you can exit from the scheme and shift your corpus to a liquid fund or even a bank fixed deposit to preserve the accumulated amount.

Either way, to protect the corpus you have amassed, when you are one or two years away from your goal, switch to less risky funds where the equity component is negligible. 

2. Want a Regular Income from your Mutual Fund Investment and Seek to Preserve your Capital? Do Systematic Withdrawal Plan (SWP)

If you want a regular cash flow from a mutual fund scheme, do not switch the same to a dividend option. It will be more efficient if you follow a SWP. This is an excellent facility, offered by mutual funds and it is also extremely tax efficient. 

When you choose a SWP plan, it allows you to redeem your investments in a phased manner. You can direct your mutual fund investments to your savings account. In a SWP, the value of a mutual fund reduces by the number of units you withdraw. 

Let’s look at the example given below to understand better. If you have your desired corpus of INR 1,000,000 in a fund, assuming that you redeem only 7% per month (INR 5,383) for a year, the amount will be taxed as per short term capital gains at 15% for withdrawals upto one year and long-term at 10% for above 1 year. Also every year the value of the fund would reduce due to withdrawal and increase/decrease due to market movements.

The total withdrawal as per this illustration is approximately INR 70,000 and if you had invested this in a dividend option, the tax liability would have been approximately INR 21,000 (assuming a 30% slab) whereas in the growth option your capital gains tax is INR 2,500.

3. A Shift in Fundamentals? Review and Rebalance

When a fund undergoes a fundamental change, the risk profile also shifts. This could be on account of a change in the fund manager, a change in the fundamental attributes of the fund or a change due to regulatory norms.

If the fund manager changes, his unique management style could affect the fund’s performance. Some of his decisions might deliver good returns while others may not, even though his decisions are well within the mandate.

Do track the fund performance over six to 12 months after the fund manager changes. If it underperforms drastically then you need to review the entire portfolio and you may need to re-align your investments in that fund. 

Some fundamental attributes of a scheme are its structure, investment pattern, etc. An example of a change in fundamental attributes could be if a banking fund changes its mandate to also include non-banking financial company (NBFCs) in its portfolio. If the changes are not in line with your investment objective, you may consider an exit option.

Regulatory changes include instances like SEBI introducing a 25% cap on large cap, mid cap and small cap each for multicap fund portfolio holding. This had caused quite an uproar and SEBI had to introduce a category called flexicap. 

Most fund houses did change their names as they did not want to rearrange their portfolios. Some funds like ICICI Pru Multicap Fund, Invesco India Multicap Fund, and Nippon India Multicap Fund realigned their portfolio as per the capping norms. 

If such changes occur and you are not comfortable with their impact on the scheme, as it does not align with your objectives, then you can exit from the scheme and rebalance your investment portfolio.

4. Consistent Underperformance of a Scheme? Switch to a New Fund

It is observed that not all schemes perform consistently and that past performance of the scheme shouldn’t be the only criteria used to invest in a scheme. But while redeeming it is vital to note the consistent underperformance of a scheme for a prolonged period.

Check for returns across various time periods and compare rolling returns of a fund that is performing poorly compared to its peers and the benchmark returns to see how inconsistent the fund’s performance has been. At times like this, an investment advisor plays a pivotal role, specifically for an investor who is not aware of the nuances of finance. 

Do research and try to understand the reason for its underperformance. Explore whether the entire scheme category has fared poorly or if the scheme is holding beaten down stocks in its portfolio, or if a fund manager has changed or if a particular sector is hit by any regulatory changes and the fund manager took undue risk. In short, find out why the scheme has performed poorly and gauge whether it is a one off case or the adverse factors will persist. This will help you in taking a call on whether you should exit or not.

If an equity scheme is underperforming continuously for three years or more as compared to its peers, you could consider exiting the scheme and transferring your investment to a similar fund that has a proven track record. But before investing in a similar fund, do a quantitative and qualitative research of the scheme. 

5. Change in Asset Allocation? Rebalance Portfolio

A change in asset allocation of your portfolio sometimes occurs due to market movements. At other times, a change in your personal situation, such as a change in age profile, necessitates a change in your asset allocation. In such cases, you could consider rebalancing your portfolio. Asset rebalancing will help you even out investment returns and could even force you to “sell high” and “buy low”.

For example, if your asset allocation is 65% equities and 35% debt. If equity markets go up and the equity allocation goes up to 70%, you may need to consider reducing your equity allocation by redeeming investments. It is important to maintain your asset allocation because it keeps your tolerance for risk at the most comfortable level. 

6. Demerger and/or Merging of Asset Management Company (AMC)? Review and Rebalance

Let’s consider the rare event that the AMC whose schemes you have invested in is sold to another fund house and the scheme gets merged with a similar scheme of the latter. Then evaluate the scheme’s performance, objective and holdings to see if they have changed or not. 

AMCs are sold for different reasons; however, it is unlikely that the objective of the merged scheme would differ from the one you initially invested in. If the performance of the merged scheme continues to be satisfactory, stay invested but if it is unsatisfactory, replace it with a similar new scheme from a different AMC.

7. There is an Emergency? Exit from the Scheme or Pause your Systematic Investment Plan (SIP) 

In case of any emergency, when your emergency fund is insufficient to deal with the situation, you can consider exiting from a scheme. If you are not able to continue to pay your SIP instalments you can also pause the monthly SIP for a while.

Most AMCs do offer an option to pause SIPs, if you find it difficult to continue because of any unforeseen emergency. Stopping your scheme investment will stop you from growing a bigger corpus and it could become difficult to start an SIP again.

The other option is to withdraw the previous SIP amounts and re-invest to continue with your investments but do not stop your SIP investment. If withdrawal is imminent, ensure you withdraw funds which are non-performing first and then the performing funds; even in performing funds first look at redemption from long-term and then short-term.

Bottom Line

Patience is the most important attribute needed in investments and specially when there are sharp dips. It is however, important to check your emotions and not get carried away by the buzz in the markets. Stay on your path of asset allocation and avoid market timing. 

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