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Top 5 Reasons To Sell Your Mutual Fund Schemes - Outside View by PersonalFN

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Top 5 Reasons To Sell Your Mutual Fund Schemes
May 16, 2017

"If you've done your work well when you're buying, the time to sell is... almost never," Philip A. Fisher, renowned investor, and author of Common Stocks and Uncommon Profits.

Almost all famous investors have made their money by buying great stocks and holding these for the long term. As an investor, you too would love to buy and hold mutual fund units without having a reason to sell. However, mutual funds are not always perfect. When planning your financial goals with mutual fund schemes, you need to be realistic.

Your buying and selling of mutual fund schemes should be carefully tuned to your long term financial goals. Unfortunately, similar to their buying decision, most investors end up selling based on the direction of the market.

Between August 2009 and April 2014 when equity markets were struggling, equity mutual funds suffered an exodus of over Rs 42,000 crore. In the two years, between January 2012 and December 2013, when the market for most of the time was flat and directionless, as much as Rs 25,000 crore flowed out.

However, as the market moved back up, retail investors have once again flocked to the market. Even now as the market touches precarious highs, equity mutual funds are enjoying sturdy inflows. Going ahead, if the market changes direction, will these same investors pack up and sell their investments? It may be very likely, given the market's history.

As a smart investor, should your investment decisions be based on the direction of the market? Certainly not!

As PersonalFN has often highlighted in the past, every investor should adopt a prudent and planned approach to investing. You need to avoid ad hoc investment decisions, either to buy or sell mutual fund units. There should be a sound reasoning to back the decision you make.

Here's top 5 reasons based on which you may consider selling your mutual fund units.

  1. Met your financial goal or emergency requirement

    Your disciplined approach to investing as finally paid off. You have been saving regularly over the past few years and now your investment goal has matured. This is the primary reason why you should sell your mutual funds.

    If your equity funds delivered better than expected returns, you may end up reaching your goal before the target date. Here again, you can redeem your equity mutual fund units and put it in low risk assets such as liquid funds. This will retain the value of the portfolio until the time you need to withdraw it to fund the goal.

    You may also need to dip into your mutual fund portfolio when there is an emergency. At such times, it would be prudent to redeem funds from low risk assets first, such as liquid fund and short-term debt funds, before moving on to riskier equity funds. Because during an emergency if equity markets are at a low, you may end up withdrawing at low returns and miss the potential of higher returns in the future.

  2. Rebalance your portfolio

    In financial planning, setting the right asset allocation and regular rebalancing your portfolio are key areas that ensure your financial wellbeing. Therefore, if you have, with the help of a financial planner, set an asset allocation based on your risk profile, investment objective and time horizon, you need to monitor it an rebalance the portfolio at regular intervals.

    Let's say you maintain a 70:30 (equity:debt) portfolio. Over the quarter or half-year, your equity funds run up considerably. This may skew your asset allocation and your portfolio may have an equity weightage of over 80%. This is when you may need to redeem the investment and reinvest in debt. Conversely, if equity markets don't perform as expected, you may need to move from debt to equity to meet the targeted asset allocation.

    You may also need to alter your asset allocation as you draw nearer to your goal. As you approach the target date for your financial goal, you may need to switch from riskier assets to low risk assets. Similarly, if there is a change in your risk tolerance, you may need to sell and reinvest your mutual fund investments to meet the desired asset allocation. As you grow older, your risk tolerance decreases, hence, you may have to shift from high risk to low risk assets.

  3. Fund underperformance

    We all make mistakes. Your mutual fund investment may not live up to your expectations because either you made a mistake to start with or a genuinely good mutual fund started deteriorating in performance.

    You may have invested in a themed fund or a sector fund expecting robust returns. However, if the sector has underperformed, you would be sorely disappointed. You may have made the mistake of taking undue risks or not adequately diversifying your portfolio. To get your portfolio back on track, you may need to sell your funds and invest in better-performing, diversified equity funds.

    At times, even a carefully selected mutual fund may underperform. The fund manager's investment bets may have not yielded the best returns. You need to review the performance before dumping the mutual fund scheme.

    Here's an example, let's say you've invested in a fund expecting, say, 15% returns over three years, but the fund delivers just 10% over this time. It is best not sell the fund just because it failed to meet your expectations. Returns of market-linked investments are volatile and may not always give you the returns you expected. So instead, compare the returns of the scheme to its benchmark and other peers in the category.

    If in the above example, the benchmark returned 5% over the period, while other schemes in the category returned around 8%, continue to hold on to it as the performance fared comparatively well. However, if the scheme has underperformed the benchmark and its peers, it may be indicative of an underlying investment issue, and you could sell your units.

  4. Change in fundamental attributes, key personnel or mutual fund policy

    The mutual fund industry is under constant change. Be it at a macro level where policies are changed or at a micro level where the fundamental attributes of a scheme are altered. Such amendments may induce you to sell. However, before doing so, you need to judge the long-term impact.

    For example, at the macro level, if there is an increase in taxes on capital gains, you will need to check if the post-tax returns is efficient compared to other products and decide accordingly.

    A change in fundamental attributes may rarely necessitate any action. For example, after the regulator allowed mutual funds to invest in Real Estate Investment Trusts (REITs), certain schemes altered the asset allocation mandate such that it specifies an allocation to REITs as well. However, this amendment just provides an enabling power to the fund and may not necessarily translate into investments in REITs.

    But if the fund is moving from an aggressive strategy to a conservative one for asset allocation or vice-versa, this is a reason to worry. This happens mostly with scheme mergers. In such cases, you need to review if the revised asset allocation or investment strategy meets your risk profile and investment objective. You can always seek the assistance of a financial planner in such cases.

    If an ace fund manager quits, many may start to have a pessimistic outlook on the scheme. However, you should note that the investment process involves an entire team. Therefore, if a fund manager quits, the investment team may be equally competent to meet the investment objective of the scheme. Therefore, you should give the new fund management time. If after a few quarters or more, the performance of the scheme fails to live up to its performance mark, sell it.

  5. A better alternative

    You may have started your journey with mutual funds through tax-savings schemes such as Equity Linked Savings Schemes (ELSSs). However, now that the 3-year lock-in period is over, you are not sure whether to hold or redeem. While some tax-saving schemes have turned out to be top performers, giving open-ended equity diversified schemes a run for their money, most other schemes have fallen short (even though they may rank among the top in the ELSS category). Thus, you may consider switching your investment in an ELSS to better performing equity diversified schemes.

    In the same way, if you can bear the additional risk, you may want to sell your investments in a balanced fund to reinvest in a large-cap fund or even a mid-cap fund based on the long-term wealth creation potential of such schemes.

The bottom line...

The market constantly goes through short-term phases of euphoria or panic. But historical data shows, over the long term, it has always moved up. This is why you need to base your buying and selling decisions not on the whims and fancies of the market, but on your financial requirement, your goals, and the underlying performance of the scheme. Sell your mutual fund units only if you have a reason as strong as one of the five highlighted above.

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PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


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May 16, 2017

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