Let me start with a confession!
I have headed Sales & Marketing with large mutual fund organisations in India and every single day of my job has been to make individuals and institutions buy mutual fund products. So, when one of my close friends asked me to write a blog on this subject, I was not only surprised but I felt that this is a question that I have rarely thought about, if at all! But as I sat down to pen my thoughts on this subject, I realised the importance of this question and getting clarity on this subject can make a big difference to your overall investment outcomes.
So, when should you redeem your mutual funds?
There are three main reasons why I believe that you may think of redeeming your investments:
- You need the money.
- You believe that there is some other investment opportunity that could do far better than your current investments.
- You are unhappy with the fund performance.
Let us examine all these three in a little bit more detail and hope we get answers that help us with better investment outcomes.
Reason # 1 : You need the money!
If you need the money, go ahead and redeem your funds! There is only one aspect that I would highlight here. If you follow a goal based approach to investing, this decision is really easy. As you approach closer to your goals, you increase your asset allocation towards cash and liquid funds and if you have been disciplined about this process, this is the best thing that could have happened.
However, in reality, there are very few individuals who fall in this category. This may work in theory but in practice that’s rarely the case.
Reason #2: You believe that there is some other investment opportunity that would do far better than your current investment.
This is where most of the mistakes happen. Investment success is not only about skill but also your behaviour! Most investors tend to invest based on the past fund performance. Imagine some asking you to invest in a gold funds at the end of 2018. It is very unlikely that you would have bought a Gold Fund as it is the worst performing asset class for the last 5 years (as of December 2018). And then Gold takes off! You believe that you have missed the opportunity and now rush to participate in it! You justify on the basis that the world is coming to an end soon and hence Gold will continue to rally for a long time!
Gold – Annual Returns (Source: Value Research)
The answer is that no one knows which asset class will do well in the future! Hence it is always recommended that you follow an asset allocation approach while investing.
Interestingly, there is a lot of research that shows the investment returns generated by invesrtors is far worse than what the underlying funds deliver. I am sure you already appreciate the reason for the same. Investors invest basis past performance!
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(3) You are unhappy with the fund performance
In this case, you did invest across various funds but you find that the fund performance is far lower than what you expected.
Before, I discuss this issue, let me give a broad context to this issue. As per AMFI data, as of June 30, 2020, there are 329 and 322 open ended debt and equity funds respectively. You are likely to invest in 3 to 5 mutual funds schemes within an asset class,, which is about 1% of the available choices. It is almost certain that there is some fund that will do better than what you have invested in! The subject of fund selection is too big a topic to cover in this blog! All I want to highlight here is that if all the funds that you picked within an asset class are doing well, then it is more than likely that when the tide turns, all your investments will do as badly!Â
Does it mean that you never get out of a fund that’s not performing well?
There are several factors that you need to assess before redeeming your fund. Under-performance of the fund is only a symptom!Â
I can give you a long list, but if there is one single factor that I personally believe and track, it is the underlying investment portfolio. The fund performance is a function of the underlying portfolio and if there is a unwarranted and a significant change, you need to reconsider your fund selection. The conviction of the fund manager gets tested when markets turn extremely volatile and that’s time you need to get extra diligent with fund reviews. This also happens when there is a change in fund manager. New managers may manage the fund very differently from the earlier managers and hence you should be more vigilant when these changes happen.Â
A well diversified portfolio implies divergence within the selected funds but with the aim of delivering an overall return that is sync or better with the overall category performance.
What is the solution?
Investment success is determined by three big factors.
First, follow goal based investing. If you are unclear about why and when you would need to redeem, your focus will be on investment returns and you are likely to make mistakes!
Second, follow the golden rule of Asset Allocation. Most investors believe that they practice this but in reality that is rarely the case. It is very difficult to invest money in asset classes that are currently not doing well. Of late, Nifty 50 (read large caps) have done well, would you still consider investing in mid or small cap funds?
Third, your behaviours will have a big impact on our overall investment performance. If you are churning your portfolios too often, it is likely that your emotions are likely to hurt your investment performance.
Conclusion
To sum it up, no investment is forever! But redeeming for the wrong reasons will lead to undesirable investment outcomes!Â
1 thought on “When should you redeem your Mutual Funds?”
Very informative and with practical approach. Can you please write an article on when not to sell share of any particular company.
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