Investors prefer redeeming mutual funds during bearish market conditions fearing further losses; others exit during bull market conditions in order to book gains at assumed peaks. However, such knee-jerk reactions to market conditions may adversely impact your wealth creation objectives.
Let’s look at five scenarios when you should be redeeming your mutual fund investments.
Achievement of set financial goal
Investment in mutual funds should always be aligned with set financial goals such as retirement, child’s higher education, marriage, home loan or car loan down payment. Redeem existing mutual funds only after you achieve the earmarked financial goals tied to those investments. In case your financial goal is just one year away from maturity and your mutual fund investments have already reached or exceeded the target corpus, consider shifting your equity mutual fund investment into financial instruments offering higher degree of capital protection such as savings account, fixed deposits and short-term debt funds. This will reduce the risk of erosion in your accumulated target corpus.
Constant under-performance of funds
A mutual fund must be able to constantly beat its benchmark index and peer funds in terms of the returns generated. If your existing mutual funds are consistently underperforming their benchmark indices and peer funds for periods of over 3-4 consecutive quarters, then you should consider redeeming those mutual funds. At times, even a sector or thematic fund may underperform due to any changes in the business cycle of the scheme’s portfolio constituents. Opt-out of such under-performing funds if you are sure that these will continue to underperform for a long time.
Also read: This fund identifies the next big sector or theme: Should you invest in it?
Portfolio re-balancing
Investors may find major deviations in the asset mix of their portfolio due to the differing returns generated by mutual funds investing in varying asset classes. For instance, assume that you set an equity-debt allocation ratio of 80:20 for your overall investment portfolio. However, extraordinary returns from equity mutual funds led by a bull market can lead to the equity component increasing beyond your original equity-debt ratio by a wide margin. To bring your debt-equity ratio back to the original level, you can redeem a part of your equity portfolio and invest the proceeds in debt funds. Similarly, during steep market corrections, you may have to do the opposite, by investing more in equities.
Changes in the investment objective of the fund
Every mutual fund scheme declares its investment strategy, scheme category and asset allocation strategy to help investors gauge these vis-à-vis their financial goals, risk appetite and investment philosophies. Hence, any change in these fundamental attributes of your existing fund can affect its suitability for you. Thus, redeem your existing mutual fund investment if any changes in its fundamental attributes cease to suit your risk appetite, investment philosophy, and set financial goals.
For example, if a large-cap fund in your portfolio changes itself to a flexi-cap scheme, the risk profile of that fund might increase than what your risk appetite allows. In such a scenario, you should go ahead and redeem that mutual fund for another large-cap fund matching your risk appetite and investment philosophy.
Appetite for risk reduces
Factors such as changes in your income or financial goals or even a prolonged financial stress can significantly alter your risk appetite. Such changes can leave your existing investment portfolio with a mismatched risk profile and, hence, would require some portfolio re-balancing. For instance, assume that your investment portfolio possesses an aggressive risk profile and tends to be skewed towards equity investments. If you suddenly witness income disruption or other financial uncertainty, you may need to ensure a higher degree of capital protection for your overall investment portfolio. This might require you to redeem some of your equity fund investments for relatively less risky instruments such as fixed deposits or debt mutual funds.
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