Investors’ thought process and behavior while choosing a mutual fund to invest in, usually mirror their behavior while exiting the investment as well. If you have chosen a mutual fund because it was doing well in the past few months, then you’ll probably feel like selling it if it underperforms for a few months. You will then move to another fund that is currently performing well and continue this vicious circle.
In reality, continuously worrying about the market conditions and obsessively tracking your returns is futile. When the market is falling, most investors panic and want to exit their investments to ‘mitigate’ their losses. The trap of wanting to invest in a ‘better performing’ investment avenue is always very tempting but very harmful.
Before panicking in times when the markets aren’t doing well, you must realize that mutual funds are actually a portfolio of financial instruments like stocks and bonds. Thus, as they are diverse portfolios with instruments having varying risks and characteristics, a decline in one or a few of the stocks can be offset by other assets within the portfolio that are either steady or increasing in value.
So, while you may want to avoid worrying about market ups and downs, there are few circumstances when you may have to exit your investments due to some pressing needs.
These are a few situations in which you should exit your mutual fund investment –
When you need the money for a goal: Most of us have tangible goals like buying a house, funding a dream vacation or providing for our child’s education, for which we save money. At least 6-12 months before you need money for a goal you should sell your equity investments and move the funds into a fixed deposit or floating rate fund. If the market is down at this point in time, see if you can utilize any other source of funds for your goal or check whether you can wait for an additional period of time. This decision on whether to ride the downturn a few months before you need money, is completely based on your risk tolerance and varies from person to person.
When you need money for a personal emergency: There might be a time when a personal emergency warrants far more money than the money you have saved in your contingency fund. At such times when Bonds, PPF and Post Office instruments might have a lock-in, you can look at selling your mutual fund investment which is not performing.
When your investment has gone sour: There are periods where your investment will underperform the broader market. Should you immediately sell at this point? We generally give any fund manager a couple of quarters of under-performance especially if he has a consistent track record of delivering risk-adjusted returns. Check out the reason for under-performance whether it’s due to high concentration to few sectors, or a fund manager change or bad market timing, etc. Generally, when a fund does too well, there is a lot of money that flows into it and hence you might see some underperformance in the funds’ performance due to excess cash in its portfolio. However, if there is a change in the fundamental attribute of the scheme and it does not match the reason you invested in the fund, you could consider exiting it in consultation with your financial advisor.
When you need to re-balance your portfolio: Asset allocation is one of the key decisions that you must make when it comes to your money and studies have proved that asset allocation accounts for almost 91 percent of your investment performance. Suppose you decide on exposure of 60 percent equity and 40 percent debt, but because of the bullish market conditions, your equity exposure has gone up to 80 percent, then to bring back the portfolio to its original allocation, you would need to sell equity and buy debt. In such cases, you can shift from an equity mutual Fund to a debt mutual fund also.
This is where consulting a good Financial Advisor will help and the advisor will not only help you with your ideal asset allocation but will also review your portfolio at least once a year, to ensure it is on track with your goals and matches your risk profile.
Thus, as you can see above there are situations where you must exit your investment irrespective of how the market is performing. However, continuously panicking when the markets go down and trying to continuously time the market is futile.
(Views expressed in this article are a personal opinion of Amar Pandit, CFA, Founder, Happyness Factory.)