When is a good time to invest? is one of the most often asked questions regarding mutual funds. Although there are plenty of solutions to this issue, the topic of when it’s appropriate to sell your mutual fund investments is one that gets less attention. When markets hit all-time highs or have a major fall, this question most frequently comes up.
In this post, we’ll go over four distinct situations in which you should think about selling your mutual fund investments as well as how to build a solid exit plan.
During Times of Severe Market Exuberance
When markets have already hit all-time highs and investors are still making more investments in anticipation of future higher movement, this is known as extreme market euphoria. Many investors frequently begin investing in stocks and investment products that they do not fully comprehend in this scenario. However, the markets quickly experience a correction, so this enthusiasm is short-lived.
Let’s look at the real story of Joe Kennedy, the father of former US President John F. Kennedy, to see how this works. Joe Kennedy was the owner of a Wall Street, New York, investing firm in 1929. His shoeshine boy began offering him stock suggestions one day while he was having his shoes polished. Kennedy came to the realization that the illogical optimism driving the US market boom was unsustainable at that very moment. He took this knowledge to heart and began selling off his investments right away. As a result, he was able to sell off the majority of his stocks at a profit by 1929, when the US stock market fell.
If you know what to look for, you can quickly identify this kind of investment activity in markets. Among these red flags are:
- Many growth stories that lack sufficient evidence of earnings
- Analysts’ incapacity to offer a plausible explanation for the increase in stock prices
- An substantial rise in penny stock prices
- massive IPO (initial public offering) oversubscription
- It could be wise to register profits and redeem your investments if you notice these red flags.
In the same way that a Systematic Investment Plan enables you to average out the cost of purchasing units, this redemption will enable you to average out your redemptions.
Two important factors should be taken into account as part of your exit strategy when you intend to book profits by redeeming your mutual fund investments:
Determine when it’s best to leave.
Comparing the valuation of small-cap stocks to large-cap companies is one method of determining when it would be wise to cash in your investment. It is wise to play it safe and book profits if small-cap stock values are 10% higher than large-cap values. This is a tried-and-true method of figuring out when to sell your mutual fund shares, even if there is always a chance that you will lose out on certain opportunities once you redeem your investments.
Reinvesting the Proceeds of the Redemption
Determining what to do with your gains is the next step in the exit strategy after you have redeemed your assets. Reinvesting your winnings in asset classes that can be used as a hedge against equities market overvaluation is the best course of action. Gold, short-term debt funds, and fixed deposits are among the available possibilities. You can improve the overall downside protection of your investing portfolio by combining these investments with stocks.
When Your Financial Objectives Are Achieved
All of us invest our savings in order to achieve a variety of immediate and long-term financial objectives. Paying for a vacation is an example of a short-term financial goal; retirement planning and home ownership are examples of long-term financial objectives. Reaching your financial objective would be a suitable cause to terminate your Systematic Investment Plan or redeem an investment.
Actually, when it comes to longer-term objectives, the exit strategy frequently begins before your investment goal is accomplished. This is because, in order to protect your money as you approach your long-term objective, you must begin shifting your assets from riskier asset classes to safer asset classes.
Let’s consider an example to make this concept clearer. Imagine you’ve been saving for years and have accumulated 85% of the cost needed to buy an apartment. Just as you’re about to make your purchase, the stock market suddenly drops by 30%. This means the value of your investments would shrink to just 60% of your target amount, setting you back significantly.
To prevent this kind of scenario, it’s crucial to start shifting your investments to safer asset classes—such as bank fixed deposits or short-term debt funds—before reaching your goal. These options are far less volatile than equity mutual fund investments and can help protect your savings from sudden market downturns, ensuring that your financial plans remain on track.
You may have considerable leeway when it comes to some long-term investment objectives. For instance, you may be able to extend your retirement by two to three years if you are preparing for your retirement and your investments begin to underperform. Your investments may have enough time to recover from unexpected market corrections thanks to this additional time.
However, it may not always be possible to extend the investment period. One example would be if you have an urgent investing goal, such as funding your child’s college education. To make sure the total risk of reaching the objective aligns with the asset classes in which you are engaged, you must take additional care in such a scenario. Redeeming your assets is the best course of action when you are getting closer to your investment goal, even though you may need to devise a suitable plan to move your mutual fund investments from riskier asset classes to lower-risk investments as you approach your objective.
To Rebalance Your Portfolio of Investments
Rebalancing your portfolio and distributing investments among several asset classes are essential components of any successful investment strategy. This procedure is intended to guarantee that your investments yield the maximum profits while posing the least amount of danger. Usually, this is accomplished by boosting allocation in underpriced asset classes and redeeming investments in overvalued ones.
The 60:40 mix, which allocates 60% to equity and 40% to debt assets, is one of the most often suggested conventional portfolios. Assume you own such a portfolio and that over the course of the year, equity markets rise by 30% while debt investments only grow by 5%. Your portfolio’s allocation will shift in this scenario, with 78% going toward stocks and only 42% going toward debt investments.
This implies that you will need to rebalance your portfolio by taking 5% of your equity assets and raising your debt allocation by 5% in order to keep the 60:40 asset allocation.
Rebalancing is based on this principle:
selling overpriced investments and reinvesting the money into undervalued opportunities. Rebalancing aids in managing the asset allocation in your portfolio to maximize returns while minimizing overall risk.
When Funds Don’t Meet Your Investment Objectives or Underperform
The performance of the mutual fund investments scheme is another cause to sell your investments. You should think about leaving a scheme in favor of one that performs better if it has persistently underperformed over the last few quarters when compared to its category rivals.
If a mutual fund’s core characteristics have altered, that’s another reason to think about redeeming your assets. After the SEBI circular for the categorization of mutual fund schemes went into force in 2018, several mutual funds experienced a change in their basic characteristics.
A mutual fund may no longer meet your investing objectives if modifications are made to its investment strategy, portfolio, scheme structure, etc. In these situations, it could be wise to leave the scheme and choose one that better suits your investing objectives.
The bottom line
Remember to consider the potential effects of exit load and capital gains taxes if you choose to leave a mutual fund investments. In order to minimize your Capital Gains Tax payouts and optimize your benefits from plan redemption, you should, if at all possible, also take use of the tax harvesting alternatives that are available.
