Often there are times when we investors need to liquidate or encash our holdings in mutual funds owing to a personal financial emergency or to invest in a better investment scheme.
The exit from the mutual fund scheme is called the mutual fund redemption. This can be done very easily in parts (specific units) or can be exited wholly.
In this article I aim to cover the ins and outs of mutual fund redemption, starting from the basics first. Read On
In this article
- Difference Between Stock And Mutual Fund Selling.
- Types Of Redemption
- Taxes On Earnings Or Gains
- Exit Loads Associated With Redemption.
- Methods To Exit From Mutual Funds
- When Should You Consider Redeeming Your Fund Units?
- Word of Caution: Strategic Exit or not?
Difference Between Stock And Mutual Fund Selling.
A typical stock market consists of a buyer and a seller. If we want to sell a stock we need to find a buyer. The stocks get sold on a mutually agreed price. The order book for the stocks reveals the buying and selling price of the broker.
Thus, for selling stocks one needs to find a buyer who is ready to buy at the desired price.
The game is different in the case of the Mutual Fund. The buyer is the mutual fund itself. The mutual fund buys the corresponding units from the seller at the current Net Asset Value (NAV) of the mutual fund unit.
Types Of Redemption
In this type of redemption, you can specify how many units of mutual funds you want to redeem back. The amount which you will be getting will be determined by the number of units we are wishing to redeem and the prevailing NAV of the mutual fund unit.
2.Amount Based Redemption
In this type of redemption, we can specify the amount which we want to redeem back. Thus, number units are automatically debited based on the NAV to match the amount we wished for.
In this type of redemption, we can redeem our entire investment from the mutual fund. However, it is important to note that there are taxes and exit loads involved in redeeming your fund units.
Taxes On Earnings Or Gains
As per the Indian Financial and Taxation System, all the gains of Investments are taxable.
For Equity-based Mutual Fund investment, if the tenure of the investment is less than a year a short term capital gain tax is applicable.
This tax rate is 15%. Whereas, if the tenure of the investment is more than a year long term capital gain tax of 10% is applicable. However, for the long term, the taxes are only applicable if the gains exceed 1 lakh Rupees.
For Debt-based Mutual Fund, the short term period is 3 years. The short term gain tax is according to the income tax slab in which we fit in. Investment gains above 3 years are termed as long term gain and they are taxed at 20%.
Exit Loads Associated With Redemption.
Most of the mutual fund expects you to invest typically for a longer time than a year. If you want to exit the fund before this time period a certain penalty would be levied. This penalty is called the exit load.
Exit load is generally around 1% of the total amount withdrawn. The minimum period for equity funds is generally around a year however for debt fund this may vary. There are short and ultra-short debt funds available, whose minimum period is usually much shorter.
You should check both these parameters before planning to disinvest our money from the mutual fund scheme.
Methods To Exit From Mutual Funds
1.Through Trading Account or Demat
If we had bought mutual fund units from our DEMAT or trading account via a broker, we need to raise a sell order through the same broker. The corresponding amount is credited to our Bank account linked with the DEMAT account.
2. Directly via AMC Or Distributors
Most of us directly buy Mutual funds from the AMC or the Mutual Fund House itself or through the distributors like Groww.
All these provide us with the online platform where you can buy, monitor or sell your mutual funds.
You can sell our mutual funds according to the methods mentioned above through these online platforms directly. Here is a short video on how you can redeem your funds on Groww.
3.Registrar or Transfer Agencies (RTAs)
RTAs like CAMS, Karvy maintain transactions and records on the behalf of mutual fund houses. We can redeem our Mutual Funds through them also.
After having discussed on all parameters of redemption, how to redeem our mutual funds, where to redeem from, etc.; the question boils down to when should we redeem?
When Should You Consider Redeeming Your Fund Units?
1.Below-par Performance By The Mutual Fund
Redeeming your funds just because of temporary market flux is uncalled . This is especially true if you are a long term investor since the markets eventually stabilize.
However, you might consider redeeming your funds if your fund underperforms consistently. By consistent underperformance, I mean that the fund delivers a negative alpha α consistently.
Alpha, α is the difference between the fund’s or portfolio’s return with the benchmark like SENSEX or NIFTY50. For instance, if Sensex goes from 36000 to 39000 the benchmark is said to deliver an 8.3% return.
If your mutual fund delivers say 6% return in the same time period, it is said to underperform with α= -2.3%.
This is a case where you may want to pause and take a look at how your investments are performing and whether it would be a good idea to direct your money to a better performing fund that helps you achieve your financial objectives.
2. Financial Emergency
There might arise a situation where we need to move our funds from the investments to some urgent capital intensive expense like medical emergency, loss of a job, giving urgent money to relatives, etc. If you have been investing in a liquid fund for emergencies, certain liquid funds allow you instant redemption that you can put to use.
3. Fund House Changes Strategy
We often invest in a mutual fund after seeing and believing the investment philosophy of the fund. The strategy they devise in picking stocks from large, small or mid-cap and targeting sectors should ideally remain constant.
However, they might change the fund strategy to capture the market more efficiently or change the fund manager.
Although the AMC is supposed to inform investors when any such changes are employed, this usually leads to investors wanting to redeem their units.
If you feel the fund’s strategy is no longer congruent with your financial goals, you can consider redeeming your units and investing in funds better suited to your needs.
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4. Financial Goal Completion
The ultimate goal of any investment is to achieve your financial goals. If we have invested for long and we have received our targeted return, it makes sense to pull out our investment and cherish over the financial rewards we have reaped from our investments.
So these situations are the best time to pull out our money from the mutual fund.
But wait, are we pulling the funds at the right time? Except for the situation of achievement of our financial goal.
Word of Caution: Strategic Exit or not?
The returns of a mutual fund are the net result of how the stocks perform. Some stocks pick up while some stocks drag. It is very likely that the portfolio of stocks your fund has might have delivered a sub-optimal performance than the benchmark.
This can be a one-off period in which the prime stocks of our portfolio our underperforming.
In these situations, we should not exit immediately. You should wait for some time, as there would be a high possibility of mean reversal and again the stocks showing green tickers.
The mutual fund managers are trained people, and they will rebalance the portfolio for target performance. Hence, any temporary market movement should not result in you panicking and exiting a fund. However, if the fund house consistently underperforms, it makes sense to exit the fund.
It is very easy to exit a mutual fund with the options mentioned above. The only thing that you must be cautious about is whether you are redeeming your fund units for the right reason or not. Also, it is important for you to be mindful of the tax aspects and the exit loads involved in mutual fund redemption and then take a decision accordingly.
Disclaimer: The views expressed in this post are that of the author and not those of Groww