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Lock-in period of mutual funds: Meaning and importance

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The liquidity of mutual funds is one of several features that make them accessible, convenient and popular among investors. However, not all schemes are highly liquid. Select few mutual fund categories have a lock-in period – a specified tenure during which the investment cannot be redeemed – and understanding this is important for investors to identify the scheme type that is suitable for their needs.

However, while it may appear restrictive at first glance, a lock-in period often serves a vital purpose, promoting disciplined investing and allowing sufficient time for the investment strategy to play out.

As you venture into the world of investing, learning about mutual fund lock in periods can save you from hasty exits and unintentional penalties. You can also miss out on tax benefits in the case of the lock-in period in ELSS Funds.

By the end of this guide, you’ll be clear about how lock-in periods work, what to do once they end, and how to spot them in your chosen scheme.

  • Table of contents
  1. What is a lock-in period?
  2. Different mutual fund lock in periods
  3. What is the lock-in period in different types of investments?
  4. Why is lock-in period in mutual funds important?
  5. What is lock-in period in ELSS mutual funds?
  6. What to do after the expiry of the lock-in period?
  7. How to check the lock-in period of a mutual fund?

What is a lock-in period?

Let’s start with the fundamentals. What is a lock-in period?

  • Simply put, a lock-in period is the minimum time frame during which you cannot redeem, transfer, or withdraw your investment.
  • It applies to several financial products, including fixed deposits, life insurance policies, and certain categories of mutual funds.
  • The idea behind a lock-in period is to reduce premature withdrawals that could undermine the avenue’s investment purpose or investment strategy and hamper specific policy objectives.

In the context of mutual funds, a lock-in period is put in place either to promote long-term holding (for example, in ELSS funds) or to cushion investors and the fund from market disruptions caused by frequent redemptions.

Different mutual fund lock in periods

Although most mutual funds do not enforce a lock-in period, certain categories mandate it:

  • ELSS (Equity Linked Savings Scheme)
    • Features a mandatory 3-year lock-in period.
    • Offers tax benefits under Section 80C of the Income Tax Act, 1961, (applicable only to old regime) up to Rs 1.5 lakh in a financial year.
  • Solution-oriented schemes
    • Two mutual fund categories fall under this: Retirement Fund and Children’s Fund. As the names suggest, both are geared towards a specific investment goal or ‘solution’.
    • Retirement funds have a lock-in period of 5 years or till retirement age, whichever is earlier.
    • Children’s funds similarly have a lock-in period of 5 years or until the child reaches age of majority, whichever is earlier.

Other than these, the following scheme types also have liquidity restrictions:

  • Close-ended schemes
    • Close-ended mutual funds require investors to remain locked in until a specific maturity date. Units of this fund can only be bought during the New Fund Offer period and sold at maturity.
    • If the investor needs funds in the interim, the units can be traded on the stock exchange and can be redeemed subject to liquidity risk and market value.
  • Interval funds
    • These funds allow redemptions only during specified intervals.
    • Investments remain locked in until the next redemption window opens. There must be a minimum 15-day gap between redemption windows. These two are listed on the stock exchange.

What is the lock-in period in different types of investments?

Lock-ins aren’t exclusive to mutual funds. Here’s a quick comparison:

Investment type Common lock-in period
Fixed deposits Varies from a few months to several years, based on the deposit tenure chosen. However, early withdrawal can lead to a penalty.
Public provident fund (PPF) 15-year maturity, with partial withdrawal permitted after a few years (the period depends upon the scheme; 5-6 years is a common range).
ULIPs (unit linked insurance plans) 5-year lock-in. Withdrawals before this period are generally not permitted, and policy lapses could incur penalties.
ELSS mutual funds 3 years from the date of investment (each SIP installment is locked individually for 3 years).
Retirement mutual funds 5 years from the date of investment or until retirement age is reached, whichever is first.
Children’s mutual fund 5 years from the date of investment or until the child attains maturity, whichever comes first.

Why is lock-in period in mutual funds important?

  • Disciplined investing: A mandatory holding period encourages investors to ride out market fluctuations. This approach can be especially beneficial in equity investments where short-term volatility is common.
  • Tax benefits for ELSS: In the case of lock-in period in ELSS funds, the scheme offers tax savings under Section 80C of the old regime on the Income Tax Act, 1961. Investors enjoy tax deductions on the invested amount (up to Rs. 1.5 lakh per financial year) in exchange for staying invested for at least three years.
  • Better fund management: When fund managers have a stable pool of assets (less prone to sudden withdrawals), they can plan investments more effectively –potentially leading to better returns for all investors.
  • Encourages long-term horizon: For certain goals like retirement or children’s education, a lock-in period aligns well with a long-term growth strategy. It prevents you from making impulsive withdrawals when markets are down or other temptations arise.

What is lock-in period in ELSS mutual funds?

ELSS (Equity Linked Savings Schemes) are tax-saving mutual funds that come with a 3-year lock-in period. Here are the key aspects:

  • Tax benefit
    •  Investments up to Rs. 1.5 lakh in an ELSS fund are eligible for deductions under Section 80C of the Income Tax Act, 1961 under the old regime.
    • This deduction reduces your taxable income, effectively lowering your tax liability.
  • Growth potential
    • ELSS predominantly invests in equities, which have the potential for higher long-term returns compared to debt instruments.
    • The 3-year mandatory holding helps you remain invested through short-term market swings.
  • Flexibility post lock-in
    • Once the 3-year period ends, you can choose to redeem the units or remain invested.
    • Each SIP installment in ELSS has its own 3-year lock-in, so plan your withdrawals accordingly.
  • ELSS lock-in vs. other 80C options
    • ELSS has the shortest lock-in among all investment options eligible under Section 80C of the Income Tax Act, 1961. For instance, Public Provident Fund has a 15-year maturity, and tax-saving FDs have a 5-year lock-in.

Due to this combination of tax savings and equity exposure, ELSS can be a suitable choice for investors looking to potentially grow wealth over time while optimising taxes.

What to do after the expiry of the lock-in period?

After the lock-in ends, you have the freedom to continue holding or exit your investment:

  • Continue to stay invested: If the fund has performed well* and aligns with your long-term objectives, consider staying invested till you potentially reach your goals. Exiting prematurely might lead to forfeiture of potential gains from compounding.
    *Past performance may or may not be sustained in the future.
  • Redeem partially or fully: If you have a specific financial goal approaching, you can opt for partial or complete redemption. Review any exit load clauses, though many funds waive exit loads after a specified duration.
  • Switch or reinvest: You may switch to another scheme within the same fund house if your risk profile or goals have changed. Or you may choose to redeem your units and reinvest them in a scheme with a different mutual fund company.

How to check the lock-in period of a mutual fund?

  • Fund documents: The Scheme Information Document (SID) or Key Information Memorandum (KIM) reveals any lock-in periods. Look for the “Load Structure” or “Key Features” section to find specifics.
  • AMFI website / fund house website: You can often find product highlights, including lock-in period details, on the AMC’s official website or the Association of Mutual Funds in India (AMFI) website.
  • Financial advisors: If you’re unsure, ask your advisor or the distributor.

Always verify this aspect before investing, especially if you anticipate needing funds within a short timeframe.

Conclusion

The lock-in period of mutual funds may seem like a constraint at first glance, but it plays a significant role in fostering disciplined investing and optimising fund strategy. Whether you’re opting for an ELSS with a 3-year lock-in or exploring close-ended schemes, it’s crucial to align your scheme selection with your liquidity requirements and investment horizon.

By understanding the lock-in period meaning, investors can better manage mutual fund lock in periods without unwanted surprises. If your primary goal is tax savings, ELSS funds can be a suitable strategy. Ultimately, whether you decide to stay invested post lock-in or switch funds will depend on your evolving financial objectives, risk appetite, and overall portfolio strategy.

FAQs

What is the lock-in period for mutual funds?

The lock-in period is the minimum time during which you cannot redeem your investment.

Do all mutual funds have a lock-in period?

No, a majority of mutual fund scheme categories do not have a lock-in period. Only certain categories, such as ELSS funds and solution-oriented schemes have one. Other open-ended equity, debt, or hybrid schemes generally allow free redemptions, subject to any applicable exit load.

Close-ended funds and interval funds don’t have a lock-in period per se, but units can be bought and sold from the mutual fund house only during specified intervals. Otherwise, investors need to buy or sell them on the stock exchanges.

Why is a lock-in period imposed on ELSS?

ELSS offers tax deductions under Section 80C of the old regime of the Income Tax Act, 1961. In exchange for this, investors have to adhere to a 3-year lock-in to encourage long-term investing.

What is the tax rebate that is available on ELSS funds during the lock-in period?

Investments in ELSS up to Rs. 1.5 lakh per financial year qualify for tax deductions under Section 80C of the old regime of the Income Tax Act, 1961. This reduces your taxable income and can lower your overall tax liability.

What is 3-year lock-in period?

The 3-year lock-in period refers to the duration you must stay invested in ELSS funds. You cannot redeem or transfer these units before completing three years from the date of investment. After the lock-in ends, you have the choice to exit or remain invested based on your financial goals.

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 an 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.

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