Before I set the context of this article, let me quickly take you to the Mahabharata.
Yes, it is relevant.
It is said that Abhimanyu learned the art of Chakravyuham from his mother Subhadra, when he was in her womb, while Arujna, his father, was explaining to her about the process.
The baby boy Abhimanyu from his mother’s womb understood till the part of entering the Chakravyuham.
However, Arjuna could not continue the story and therefore, Abhimanyu did not know how to get out of it.
While waiting for Arjun to return, Subhadra went to sleep.
That’s how Abhimanyu only knew how to pierce into a Chakravyuham but not the way out.
Abhimanyu had to sacrifice his life.
A similar analogy can be applied to mutual funds.
Entering a mutual fund is very easy, but at the same time, one must have an exit strategy in place.
While everyone around will explain to you how to invest, where to invest, when to invest and much more, not many would touch upon the topic of withdrawing money from your funds.
So today, we seek to discuss how to draw out money from a mutual fund and what should your strategy be?
To start with, like the government announced disinvestment in some of its companies, similarly, you should have a disinvestment plan, as it is an essential part of your investment.
Okay, now this may sound illogical because you must have heard about, “SIP Sahi hai” and the importance of long-term investments from multiple sources.
Everyone talks about investing, and no one pays heed to the withdrawal.
What is your investment goal?
Let me take a step back and ask you, what is the goal of your investments?
The answer would be – to accumulate capital, to purchase car/house/farmhouse, or even go on a vacation.
Thus, the moment your goal is accomplished you must redeem your investments and take back the money to your bank account with an aim to execute your dream of buying that big house, a luxury car and a foreign holiday
Therefore, it must be self-evident by now that the manner and timing when you plan to redeem your investment is significant.
This exit strategy may not work for instruments where assured returns are generated, such as PPF or bank deposits, but it is very crucial for an individual who is investing in equity-oriented mutual funds to meet his/her financial goals.
Should you withdraw money from mutual funds?
Let’s talk about retail investors like you and I.
How should you exit from a mutual fund?
Retail investors, particularly the young salaried class has opted for Systematic Investment Plan (SIP) to achieve their specific life goals that can be owning a house, education, marriage, retirement, vacation or anything else.
Indian market sees an inflow of over Rs.3000 crore per month by way of SIP that is humongous in itself.
SIP in equity-linked mutual funds that fetches higher returns when compared to their fixed income counterparts has helped investors achieve their goal.
While the SIP mode undoubtedly helps an investor shield himself from market volatility, he is not immune to market shock.
This is one of the problems when an individual is investing to meet his/her financial goal.
Let us understand this with an example
Assume you are 25 years old, and you start investing for your house down payment that is due in five years’ time.
Looking at a five years horizon, you choose to invest Rs.5000 per month in an equity fund that fetches 15% annualized returns.
The first SIP installment is debited on January 1, 2014, and you need to withdraw the money by December 31, 2018.
With a strong upward movement in the market, your money grows until December 2017 but starts to crash in January 2018.
As a disciplined investor, you continue your SIP with an aim to average the cost of investing.
Let’s say the market remains volatile in 2018, and your investments don’t grow until August 2018.
On the contrary, the value of your investments started to crash considerably in September and October 2018, thereby leaving you with a shortfall of your down payment by 10-15%.
Returns as of October 12, 2018
Returns until December 31, 2017
As can be seen from the charts above, the gains accumulated until December 2017, starts declining in 2018.
What went wrong with your planning?
At first glance, you may feel nothing was wrong, as the equity market never comes with assured returns but when you look closely, you understand that the planning lacked an exit strategy.
So, what can be done about this? How can you protect yourself from such volatility that leads to a shortfall in goals?
The answer is pretty simple and no advisor will discuss that.
what is an alternate solution to extracting money from your fund?
Similar to the way you invest money by way of SIP, there are two ways of withdrawing money, also known as the Systematic Withdrawal Plan (SWP) or Systematic Transfer Plan (STP).
We are sure you must have heard of these terminologies.
Conceptually, the idea is straightforward. All you need to do is safeguard your wealth accumulation one year before the actual date when you may need the capital.
About 9-12 months before your due date when you need the money, you can start moving out a fixed amount from your fund to a stable debt fund.
This transfer or partial withdrawal needs to be done in monthly installments and not in one shot.
You must be wondering that this must be a time-consuming effort?
You just need to instruct your fund house, and they will take care of the remainder.
Thus, you get to accumulate the entire exit value in a comparatively safer debt fund and redeem the same as per your requirement and investment goal.
This method also has a flip side.
It is a possibility that while you systematically extract money from equity to debt fund; you may lose on the value of the fund, if the market rises during this period.
So remember, what you do with the exit strategy on when you need the money and for what purpose.
If your requirement is flexible and can be postponed for a year or two, you can wait before withdrawing the money systematically.
Otherwise, you can opt for a safe exit.
To conclude, this exit plan is also suitable for retirees or anyone else who needs a regular income from investments.
So, the basic principle is – always move money to a less volatile investment instrument a year before it is to be used.
And make sure you think through the process of withdrawing money from mutual funds.
Disclaimer: The views expressed in this post are that of the author and not those of Groww