Most of mutual fund investors can easily decide when to invest, where to invest and how to invest, but most fail to understand when to get out of our investment. While everyone is talking about the right time to invest, let’s focus here on when to exit from investments, as this is one of the most important parts of achieving financial goals.
We often become impatient with our exit plan from mutual fund schemes. Being confident in an exit strategy is especially important when markets are weak and volatile. Without the Exit strategy finalized, investors panic and exit based on sentiment rather than a well-planned strategy. It will lead to not achieving financial goals.
Many times investors try to time the markets by exiting their investments with the hope to re-invest at lower levels. This is a classic case of “market timing”. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
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 get out of a mutual fund is just as important as knowing when to get out and it can make or break your wealth-building process. Withdrawal from the fund should not be done based on market changes unless there are emergencies. One must do it thoughtfully, with a plan of action.
Here are a few situations where an investor should consider exiting 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 not losing and keeping the full corpus amount. The closer you get to your goal, your ability to take risks reduces. Remaining invested in the equity fund once the goal has been reached may be unprofitable at some times.
If you have achieved your financial goal earlier than planned, you can withdraw from the scheme and transfer your amount to a liquid fund or hybrid fund to save the accumulated amount.
Either way, to protect the corpus you have invested and earned a profit, when you are one year away from your goal, switch to less risky funds where the equity component is negligible. We also have to keep in mind that due to the compounding effect last years of investment would be a larger profit than the initial years of investment.
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, the SWP plan would be an efficient one. This is an excellent facility, offered by mutual funds and it is also extremely tax efficient. People with retirement plans would choose this type of exit strategy in the last stage of the investment cycle.
When you choose an SWP plan, it allows you to redeem your investments in regular intervals. You can direct your mutual fund investments to your savings account. In SWP, the amount of mutual funds decreases with the number of units you withdraw and the remaining amount in the folio would according to the market situation.
3. A shift in fundamentals? Review and rebalance your mutual fund
When a fund undergoes a fundamental change, the risk profile also shifts. This may be due to a change in the fund manager, a change in the fundamentals 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 may bring good results while others may not, although his decisions are within the scope of his authority.
The track fund performance for six to 12 months after the fund manager changes. If it does not work well you will need to review the entire portfolio and you may need to reorganize your funds into that fund.
Some fundamental qualities of a scheme are its structure, investment pattern, etc. An example of a change in assets should be if a bank fund changes its mandate to merge with a non-bank financing company (NBFCs) in its portfolio. If the changes do not fit your investment objective, you may want to consider exit options.
Regulatory changes include instances like SEBI introducing a 25% cap on large-cap, mid-cap, and small-cap each for multi-cap fund portfolio holding. This had caused quite turbulence 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 procedures.
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 mutual 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 important to note the consistent underperformance of a scheme for an extended period.
Check for returns across various time periods and compare the 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, a mutual fund distributor plays a pivotal role, specifically for an investor who is unfamiliar with financial terms.
In short, find out why the scheme has performed poorly and check whether it is a one-off case or the negative aspects will continue. 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 quantitative and qualitative research of the scheme, if not seek help from a mutual fund distributor.
5. Change in asset allocation? Rebalance portfolio
A change in the 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, requires 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 purpose of the integrated plan will differ from the one in which you originally invested. If the performance of the integrated scheme continues to be satisfactory, always invest but if it is not satisfactory, replace it with a new system similar to 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 installments 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 unexpected emergency. Stopping your scheme investment will stop you from growing a bigger corpus and it could longer time to reach the financial goal planned initially.
The other option is to withdraw the previous SIP amounts and re-invest to continue with your investments but that does not stop your SIP investment. If the withdrawal is about to happen, ensure you withdraw funds that are non-performing first and then the performing funds; even in performing funds first look at redemption from long-term and then short-term.
Patience is the most important quality needed in investments and especially when there are sharp dips. It is, however, important to check your emotions and not get carried away by the buzz in the markets. If investors can predict when the market will go up and down, they can make trades to turn that market move into a profit.
Make sure you start withdrawing systematically by transferring your investments into less volatile and risky funds at least six months prior to your goal achievement. Stay on your path of asset allocation and avoid market timing.
We can discuss how to exit from the fund and things to keep in mind while exiting a mutual fund in detail in the next article.
2 comments
Good Information ❤️✅
Glad that you liked the content 🙂