In July 2023, the Nifty 50 and Sensex 30 indices hit all-time highs. Along with the major indices, some other indices in the mid and small-cap categories also hit all-time highs. Since then, in August, the major indices traded near all-time highs. The mid and small-cap indices continued to make fresh all-time highs.
With most indices either at all-time highs or near all-time highs, the mutual fund schemes in your portfolio must be showing good returns. There will be a temptation to redeem the mutual fund units and book profits. Some investors will attempt to time the market by booking profits now and redeploying proceeds later when there is a correction.
Market timing is not a good idea because many times, even the experts get it wrong. Because markets are near or at all-time highs, it should not be a reason to redeem your mutual fund units. Let us look at some reasons when and why you should redeem your mutual fund units.
The financial goal corpus has been achieved ahead of time
You have invested in a particular equity mutual fund scheme with an expected return of, for example, 12% CAGR. However, the scheme does better than expected, with a return of 15% CAGR. As a result, your financial goal corpus will be achieved ahead of time. In such a scenario, you can redeem the mutual fund units as the goal has been achieved.
The financial goal timeline is approaching
Equity markets are volatile and can experience big falls in a short period. Hence, as the financial goal timeline approaches, you should shift from equity mutual funds to balanced or debt funds. For long-term financial goals, you may shift from equity mutual funds to balanced or hybrid mutual funds 3 years before the financial goal timeline. Later, you may shift from balanced/hybrid funds to debt funds 1 year before the financial goal timeline.
You need to revert to base asset allocation with portfolio rebalancing
As part of asset allocation, you may have invested in various asset classes such as equity, fixed income, gold, etc. Over a period of time, let us assume that equities outperform. As a result, your portfolio will be heavily tilted in favour of equities compared to fixed income and gold. In such a scenario, you should rebalance your portfolio and revert to the base asset allocation. To do that, you will have to redeem some of your equity mutual fund units and invest the proceeds in fixed-income and gold.
Changes in the scheme
At times, there are changes in the mutual fund scheme. Some of these changes can include a change in the fund manager, the scheme is to be merged with another scheme, the AMC has been taken over by another AMC, etc. In such a scenario, you may evaluate whether you want to continue with the scheme investments, pause, or redeem the units.
Life is uncertain. An unexpected financial emergency may hit you. In such a scenario, you may have to pause your mutual fund investments or even redeem them as a last resort. However, it is best to have a separate emergency fund for financial emergencies so that you don't have to dip into your investments during such situations. Depending on your financial position, job stability, your company's financial situation, the industry you work in, etc., you may build and maintain an emergency fund equivalent to 3-9 months of your monthly income.
Change in financial goal
You may be accumulating money for a specific goal, such as a vacation, down payment to buy a vehicle, start a business, etc. Over a period of time, you may realise that you will need a lower amount than planned. Sometimes, you may decide to drop a particular financial goal altogether. In such a scenario, you may need to pause or redeem the mutual fund units.
Significant changes in taxation
At times, there can be a significant change in how a mutual fund product is taxed. It may necessitate a relook at whether you should continue investing in that product or pause or redeem the investments.
For example, the Government changed the taxation of debt funds from 1st April 2023. Earlier, if you sold debt funds after a holding period of 3 years, the long-term capital gains (LTCG) were eligible for indexation benefit and taxed at 20%. From 1st April 2023, the capital gains from investments in debt schemes (where the equity component doesn't exceed 35%) are treated as short-term capital gains (STCG). The STCG will be taxed at the individual's income tax slab rate. The indexation benefit and the LTCG tax rate of 20% have been done away with.
You may evaluate the investment product when such significant tax changes are announced. If required, you may pause or redeem the mutual fund units and reinvest them elsewhere.
The performance of the scheme is consistently lower than expected
You should review the performance of your equity mutual funds regularly, once every six months or annually. You should compare the performance with the benchmark, the overall market, your expected rate of return, etc. You may review your investment decision if the scheme's performance is consistently lower than expected. In such a scenario, if required, you may pause or redeem the mutual fund units.
Found a better opportunity to invest in
If you have found a better opportunity to invest in than the existing mutual fund scheme, you may consider pausing or redeeming the scheme units. However, before deciding, evaluate the new investment opportunity on parameters such as risk involved, expected returns, liquidity, taxation, minimum investment amount, etc.
Consider the taxation before deciding to redeem
We have discussed the various scenarios in which you may decide to redeem your mutual fund units. However, before redeeming the mutual fund units, consider the taxation of the capital gains.
For example, if the holding period for equity mutual funds is more than a year, the first Rs. 1 lakh LTCG in a financial year is exempt from taxation. The incremental LTCG is taxed at 10%. If you are close to completing a year of investment time horizon, you may hold on till you complete a year and then redeem.
To conclude, markets at all-time highs are no reason to redeem your mutual fund units. Redeem them only if any of the above scenarios arise that necessitate redemption.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.