When may you consider exiting a mutual fund scheme? Guidelines and strategies

Mutual funds provide a convenient and affordable way to participate in financial markets through a professionally managed and diversified basket of stocks, bonds and other securities. However, sometimes, investors may need to exit a mutual fund scheme to protect their financial interests or to meet an unforeseen expense.

Read on to understand when you may consider selling your mutual fund units and the step-by-step process to withdraw your money.

• Table of contents

• What is a mutual fund exit strategy?
• When you could consider exiting a mutual fund

What is a mutual fund exit strategy?

There is no universal strategy to exit mutual funds. The decision depends on multiple factors specific to your financial situation. However, some general guidelines include the following:

• Review investments at least once a year: Analyse if the fund's performance, costs, investment objectives and portfolio still align with your goals, time horizon and risk tolerance.
• Establish predefined exit criteria: Decide specific metrics like sustained underperformance over 3 years, excessive risk profile deviation, change in fund manager, etc. that could cause you to consider an exit from that fund.
• Rebalance your portfolio periodically: If a fund grows too large compared to your other assets, redeem units from it to restore your target asset allocation. This helps manage risks.
• Account for life changes: Events like marriage, childbirth, new job or retirement may alter your investment horizons or goals. Review funds in this context.
• Have a cash reserve for emergencies: Keep 6-12 months' expenses in liquid assets to handle medical or income emergencies without redeeming long-term investments.

The core principles driving these strategies are evaluating mutual funds vis-à-vis your specific needs, having an exit roadmap and not emotionally attaching to any investment.

Also Read: How do I withdraw money from mutual funds?

When you could consider exiting a mutual fund

While mutual funds are meant to be held till you potentially reach your goals, there are some situations where exiting a fund may be required. These could include:

• For rebalancing your investment portfolio

Rebalancing involves realigning the proportions of various asset classes in your portfolio to your original desired allocations. If equity funds have grown multi-fold, they may form a larger percentage of your overall portfolio than initially planned. Redeeming a few equity units and diverting them to debt funds can rebalance asset allocation to bring it to your desired risk level.

• Change in the fund’s investment objectives

Funds may change their investment style, strategy or risk profile over time owing to factors like a new fund manager taking over. Analyse if such changes cause the fund to deviate significantly from your intended investment selection criteria or risk appetite. Exiting the fund for a better aligned alternative makes sense in cases of fundamental deviations.

• Underperformance relative to benchmark and peers

Consistent lagging underperformance compared to benchmark and category peers could be a cause for concern. Review such long-term under-performers and consider replacing them with better-performing funds with comparable mandates. However, such a decision should be made with due consideration. Brief periods of underperformance need not be a cause of concern. For instance, the fund manager may have adopted a long-term strategy that may underperform in the near term, or the securities in the portfolio may have underperformed the broader market. However, sustained underperformance could merit withdrawal. Consulting a financial advisor at this stage is recommended.

• High management fees

Funds charging excessively high management fees can eat into your gains. You may choose to exit such funds in favour of lower cost schemes. However, look at both funds investment strategy and historical performance to see if the switch may be beneficial. If the new fund’s track record* suggests lower return potential than your current scheme, then the lower expense ratio may not make up for the difference. *Past performance may or may not be sustained in future. Similarly, if the investment strategy does not align with your goals and investment preferences, such a switch may not be suitable.

• Risk profile no longer matches your goals

Carefully evaluate if the risk profile of a fund you bought years ago still matches your current risk appetite. For instance, when you are near retirement, a very high-risk aggressive growth fund may no longer be suitable. Switch to a lower risk scheme that aligns with your needs.

• You need money for personal expenses

Major personal expenses like children's marriage, house down payment, medical treatment etc. may require redeeming mutual fund units to arrange for funds. However, having an emergency corpus or a separate corpus for short or medium-term goals can help you meet such needs without exiting long-term investments.

• The fund management changes

If the fund manager changes, evaluate the new manager's track record and style.

Also Read: What is mutual fund redemption

Conclusion

Regularly reviewing your mutual funds and having a predefined exit strategy helps take action when needed to optimise your portfolio's ability to meet financial goals. Key aspects include evaluating if the fund's risk characteristics, costs, and investment style still match your requirements and if its performance is in line or better than that of its peers. Also stay alert for major shifts in the fund's leadership, style or your needs.

FAQs:

What is a suitable time period to judge a mutual fund's performance?

Ideally, a mutual fund's performance should be evaluated over multiple cycles to assess how it fares across bull and bear phases. Comparing year-on-year returns is less effective as even weaker funds can post good 1-year returns in bull markets while stronger funds can underperform in bear phases. However, consistent underperformance over three or more years could warrant closer review.

Can I redeem a portion of my mutual fund units instead of the full amount?

Yes, mutual fund investors have the flexibility to redeem either a part of their unit holdings or the full amount.

What are the steps involved in redeeming mutual fund units?

If you have invested directly with the mutual fund company, you will need to log into the company’s website or contact them offline and select the scheme and number of units you wish to redeem. If you have chosen a third-party investment platform, the online process may be similar.

If you have invested through a mutual fund distributor, you can contact them and ask them to initiate the redemption on your behalf.

Once submitted, the fund house processes your redemption request based on the applicable Net Asset Value (NAV).

What are the taxation rules when redeeming mutual fund units?

The tax rate depends upon the type of mutual fund and the holding period. For equity-oriented mutual funds, short-term capital gains (levied on units held for less than 12 months) are taxed at 20%. Long-term capital gains (applicable on units held beyond 12 months) of up to Rs. 1.25 lakh in a financial year are tax-exempt. Thereon, the tax rate is 12.5%.

For debt-oriented mutual funds, all capital gains are deemed to be short-term capital gains regardless of the holding period and are taxed at the investor's applicable income tax slab rate.