When should investors decide to redeem their mutual fund investments?

New Delhi: During July 2023, both the Nifty 50 and Sensex 30 indices reached record breaking peaks. Notably, several mid and small-cap indices also attained their all-time highs during that period. Moving into August, the major indices maintained their proximity to all-time highs, while the mid and small-cap indices consistently marked new all-time highs.

Given that a majority of indices are currently either at record highs or very close to them, it's likely that the mutual fund schemes in your portfolio are delivering strong returns. This may tempt you to consider redeeming your mutual fund units to realize gains. Some investors might be inclined to try timing the market by cashing in on profits now and reinvesting the proceeds when a market correction occurs.

Attempting to time the market is generally ill-advised because even seasoned experts often make incorrect predictions. The fact that markets are currently at or near all-time highs should not be the sole reason for redeeming your mutual fund units. Instead, let's explore specific situations and reasons that may warrant redeeming your mutual fund units.

Financial goals achieved before time

You've invested in an equity mutual fund scheme, initially anticipating a 12 per cent Compound Annual Growth Rate (CAGR) return. However, the scheme outperforms expectations, delivering a remarkable 15 per cent CAGR return. Consequently, your financial goal corpus will be realized earlier than planned. In this situation, you have the option to redeem your mutual fund units since your goal has been accomplished ahead of schedule.

Target date for financial goals fast approaching

Equity markets are known for their volatility and the potential for significant declines in a short span. Therefore, as your financial goal's timeline approaches, it's advisable to consider transitioning from equity mutual funds to more balanced or debt-oriented funds.

For longer-term financial objectives, you might want to begin this transition from equity mutual funds to balanced or hybrid mutual funds approximately three years before the target date. As you get closer to your financial goal, you can further adjust your strategy by shifting from balanced/hybrid funds to debt funds about 1 year before the goal's timeline.

Frequent portfolio rebalancing

In your asset allocation strategy, you may have allocated investments across different asset classes like equities, fixed income, and gold. Over time, let's assume that equities deliver superior performance, causing your portfolio to become significantly skewed in favor of equities compared to fixed income and gold.

In such a situation, it's advisable to rebalance your portfolio and return to the original asset allocation. To achieve this, you'll need to redeem a portion of your equity mutual fund units and reinvest the proceeds in fixed income and gold assets.

Unwanted changes in mutual fund schemes

Occasionally, mutual fund schemes undergo modifications. These changes may involve shifts in fund management, merger plans with another scheme, the acquisition of the asset management company (AMC) by another entity, and more. In such instances, you may need to assess your preference for either retaining your scheme investments, temporarily pausing them, or redeeming the units altogether.

Fiscal emergencies

Life is unpredictable, and unexpected financial emergencies can arise when you least expect them. In such circumstances, you might find yourself needing to temporarily halt your mutual fund investments or, as a last resort, redeem them. However, the ideal approach is to establish a dedicated emergency fund to cover such unforeseen expenses, sparing your investments from depletion.

The size of your emergency fund should be determined by various factors, including your financial situation, job stability, the financial health of your employer, the industry you work in, and more. Generally, it is recommended to maintain an emergency fund equivalent to 3-9 months' worth of your monthly income to ensure you have a financial safety net in place.

Sudden changes in financial goals

You might be saving up for a particular objective, such as a vacation, a down payment for a vehicle, or to kickstart a business venture, among other possibilities. As time goes by, you may realize that your financial target is lower than initially anticipated. In certain cases, you might even opt to completely abandon a specific financial goal. In such circumstances, you may find it necessary to temporarily suspend or redeem your mutual fund units.

Changes in taxation rules

Occasionally, there can be substantial alterations in the tax treatment of mutual fund products, prompting a reconsideration of your investment strategy. In such cases, you may need to assess whether it is advisable to continue investing in the same product or consider pausing or redeeming your investments.

For instance, the Government implemented a change in the taxation of debt funds starting from April 1, 2023. Previously, if you sold debt funds after holding them for at least 3 years, the resulting long-term capital gains (LTCG) were eligible for indexation benefits and taxed at a rate of 20 per cent.

However, since April 1, 2023, capital gains from investments in debt schemes (where the equity component doesn't exceed 35 per cent) are now treated as short-term capital gains (STCG) and are taxed according to the individual's income tax slab rate. The indexation benefit and the LTCG tax rate of 20 per cent have been eliminated.

In light of such significant tax changes, it is prudent to review your investment product and, if necessary, consider pausing or redeeming your mutual fund units before exploring alternative investment options.

Losses in mutual fund schemes

It's important to conduct regular assessments of your equity mutual funds, either semi-annually or annually. During these reviews, it's advisable to gauge the fund's performance against key benchmarks, the broader market performance, and your anticipated rate of return. If you find that the scheme consistently underperforms compared to your expectations, it's prudent to reevaluate your investment decision. If necessary, you can then consider pausing or redeeming your mutual fund units.

Better investment opportunities

If you come across a more promising investment opportunity than your current mutual fund scheme, it's worth contemplating whether to temporarily halt or redeem your scheme units. Nevertheless, before making a decision, it's essential to thoroughly assess the new investment prospect based on factors like risk level, expected returns, liquidity, tax implications, minimum investment requirements, and more.

There are numerous reasons why investors may contemplate redeeming their mutual fund units, but it's crucial to consider the tax implications before doing so.

For instance, in the case of equity mutual funds held for over a year, the initial Rs. 1 lakh of Long-Term Capital Gains (LTCG) in a fiscal year is tax-exempt, while any additional LTCG is subject to a 10 per cent tax.

If you are nearing the one-year mark in your investment horizon, it may be advantageous to wait until the year is completed before redeeming.

In conclusion, market conditions being at all-time highs should not be the sole basis for redeeming your mutual fund units. You should only consider redemption if any of the aforementioned scenarios arise, warranting such action.