The sudden need for money can cause many people to go berserk and resort to dire ways to get access to funds to finance their short-term needs. Many of them unwilling to dig into their fixed deposits turn to mutual fund redemption. This also explains why many investors redeem their mutual funds within two years of investing their money in them.
However, amidst all the clamor regarding high-interest loans or the fear of being unable to repay such loans on time, some people think of redeeming their fund units to meet their short-term or emergency fund requirements.
Experts believe that pledging your units to meet short-term financial needs would be a far better option than getting rid of these instruments that can help you garner enough returns over the next five years. While assessing your ability to repay loans, you must check the loan tenure. Loans sought for five or more years are long-term loans while any loan that must be repaid within a shorter period must be classified as a short-term loan.
Repaying a short-term loan by redeeming investments bought with a long-term perspective not only beats logic but also demeans the reason for having allocated your earnings to them.
Mutual fund investments are made with the idea to generate wealth and create a sizeable corpus in the long run. The idea behind putting money in equity funds can be anything, be it planning your retirement, buying a house, funding your children’s higher education and marriage, or any other.
However, borrowers must also check for the fund’s performance before deciding whether continuing their investments will be worth it. For example, if the investor realizes that the fund has not been performing well for the past five years or has been far lesser returns than its competitors, redeeming its units to repay the loan may not be such a bad prospect after all.
Some people also redeem their funds for portfolio rebalancing, thus, allowing them the dual benefit of fund redemption and loan repayment with the amount.
Most funds deliver 10-12 per cent returns over five years, while the interest rate on loans is somewhere around 8-9 per cent. This explains how you will be losing out on the returns over and above the loan rate if redeemed unknowingly.
Instead of redeeming your fund units, you might as well pledge them or secure them as collateral, thus, allowing you the benefit of low-interest secured loans while earning returns from your fund investments.
When taking out a loan against mutual funds, an overdraft facility is offered, allowing borrowers to withdraw the much-needed amount and repay the same without paying any additional prepayment fee. Only the amount you have used and the time you have used it are subject to interest. No interest is charged if no money is withdrawn, which is an excellent way to have emergency funds at your disposal while also earning returns on investments.
Instead of redeeming units, securing them as collateral for the necessary loans ensures the following benefits:
- Ensuring enough liquidity while allowing you to stay invested.
- Allows benefiting from the compounding effect in mutual fund investments.
- Shields against the burden of short-term capital gains tax, exit loads, and redemption charges.
- Lower interest rates charged compared to unsecured loans.
- The flexibility of loan repayment even as your funds are earning market-linked returns.
- Benefiting from the choice of the loan amount.
Emergencies are sudden, which is why you must always be prepared for them. Having an emergency fund in place ensures that you have enough money in hand to meet requirements. Setting aside a part of the emergency corpus ensures quick redemption along with interest.
However, if you still need money to pay for your short-term needs, taking a loan against securities would serve you better than redeeming your fund units and harming your financial goals in the long run.