Mutual Funds Exit Strategy
Most of us give much-needed attention to various factors while buying a mutual fund, but seldom do we give any importance to the factors that warrant selling a mutual fund investment. While the benefits of investing, especially in equity funds, are derived in a longer time frame, that doesn’t mean one should forget about these investments and only take a look at them as the goal nears its target. This is because there are various factors that impact the growth journey of investments. In this article, I highlight the importance of the right time to sell mutual fund investments in the financial planning process and look at the major scenarios under which investors could take an informed decision to exit their mutual fund investments.
When to Sell?
While it’s true that mutual fund investments should be for the long term, a smart investor must also know when to make an exit and sell his or her mutual fund holdings. For most investors though, deciding when to sell their investments poses one of the biggest dilemmas of investing. In fact, one of the most common mistakes that investors make is that they react to the short-term movements of equity markets and sell when the market falls, thereby missing out on the long-term gains from equity. Here are some of the scenarios when an investor could consider selling and exiting from a mutual fund investment:
- Fund is consistently underperforming: An investor must regularly monitor his or her mutual fund holdings to weed out the under-performers. Thus, if a scheme consistently underperforms vis-à-vis its benchmark and category returns, an investor should take a fresh look at it and after determining the cause for the under-performance, take a call to exit the scheme and invest in a better-performing scheme in the same category. The investor must not base his decision on short-term underperformance of a quarter or two, however, but only exit if the scheme is underperforming for a longer period.
- Change in fund’s attributes: Following the recent reclassification of mutual fund categories, many mutual fund schemes have changed their mandate. For instance, a diversified equity fund has changed its mandate to become a purely large-cap equity fund, which may or may not be able to generate as much alpha as its previous avatar. In another case, a small and mid-cap fund has changed focus to become a purely small-cap fund, which by nature would be more risky than its earlier mandate. In such a case, an investor could exit the fund if it no longer matches his risk and return profile.
- Change in investor’s risk – return profile: Many a times, an investor’s risk-taking ability may undergo an abrupt change due to unforeseen circumstances, which may also necessitate a change in his or her existing investment plan. For instance, an investor has aggressive risk profile whose investment portfolio is skewed towards equity. But due to some unforeseen financial circumstances, her risk profile has changed to conservative. Hence, her financial planner suggests that she reallocate her portfolio towards less riskier assets. Accordingly, she should sell some of her investments in equity funds and deploy the same in debt funds.
- Re-balancing the portfolio: Suppose an investor has a debt-equity allocation target of 40:60 in favor of equities. His equity portfolio has appreciated rapidly following the bull run of 2017 and now accounts for 80% of his portfolio. In this case, it would be prudent for the investor to reassess his investments and sell some of his equity mutual fund holdings to re-balance his portfolio. Re-fund managerbalancing is essential as it enables an investor to keeps a check on and curtail his risks.
- Achieved the goal: The main objective of financial planning is to achieve the set financial goals in a pre-defined way. In the case of medium- to long term goals, if the goal amount is achieved well before the timeline, it is prudent to safeguard the investments from adverse market conditions. For instance, an investor invested in a systematic investment plan in a hybrid fund to reach his goal of purchasing a car three years from the start of the investments. However, his investments were able to generate higher yield and thus reach his goal amount within two years. In such a case, it makes sense for him to exit the fund and shift his savings to a less risky product type like liquid fund to ward off any risks to the portfolio value from market volatility. Similarly, when it comes to retirement savings, most financial planners advise investors to systematically withdraw their investments from equity mutual funds and shift to safer debt funds a couple of years before retirement to avoid the risk of a sudden market shock eroding their savings.
Before Hitting the Exit Button
It is imperative that investors follow a well-thought-out process for exiting their mutual fund investments. While an investor must be agile in taking an exit call if there is a change in his scheme’s risk profile or investment attributes, he or she should not hastily move out of a fund just because it has under performed in a couple of quarters or only because there is a change in the fund manager.