Every saver knows that there are numerous mutual fund schemes and choosing a suitable one to invest in can be a difficult task. Everyone also has a way around it. They either seek the help of advisers or websites or just ask around. However, there’s actually an even more difficult choice that investors face-which funds to sell off and when. In the article below the author tries to help investors understand logic of selling mutual funds from one’s portfolio.
When should investors sell their mutual fund holdings?
By Dhirendra Kumar
Every saver knows that there are numerous mutual fund schemes and choosing a suitable one to invest in can be a difficult task. Everyone also has a way around it. They either seek the help of advisers or websites or just ask around. However, there’s actually an even more difficult choice that investors face-which funds to sell off and when.
Curiously, it is the more knowledgeable and more involved investors who face this problem. The reason is those of us who are active and involved investors always have an urge to do something. Such investors generally do well because they learn, analyse and act more than others.
Soon enough, they start equating being good investors with doing something, often anything. Unfortunately, along with everything else, in practice, this also translates into being all too ready to sell off their investments.
There are many reasons for selling mutual funds, but not all of them are good. There can be exceptions, but the good reasons tend to be about the investor’s own finances and the wrong reasons tend to be about the fund. Let me explain.
Overactive investors give three reasons for wanting to sell off a fund investment. One, they’ve made profits; two, they’ve made losses and three, they’ve made neither profits nor losses. This may sound like a joke but it isn’t. Someone will say, “Now that my investments have gone up, shouldn’t I book profits?” Or, “This fund has lost a bit of money recently, shouldn’t get out of it?” And finally, “The fund has neither gained nor lost, shouldn’t I sell it?” Basically, what I’m saying is that investors who have a bias for continuous action can create a logic for taking action out of any kind of situation.
So which is the right reason for selling a fund? Obviously, none of the above. By themselves, they are not legitimate reasons for selling a fund.
The first comes from the spurious ‘booking profits’ concept that advisers have promoted. Booking profits doesn’t make sense for stocks, and it makes even less sense for mutual funds. In both, this attitude makes investors sell their winners and hang on to their losers. In mutual funds, the whole point is that there is a fund manager who is deciding for you which stocks to sell and which to buy. If the fund manager is doing this job well, then the fund will be giving good returns. Therefore, selling a fund that has made good returns is the exact reverse of what investors should be doing.
Let’s come to the second reason now. While selling underperformers is a legitimate idea, you need to evaluate the timeframe and the degree of underperformance. Investors try to sell funds that have generally performed very well but may have underperformed other funds by small margins. Someone will say that over the last year, my fund has generated 25% but five other funds have generated 30%, so I will switch to those. This switching based on short-term past performance is counter-productive and does nothing to improve your future returns. Only if a fund underperforms consistently for two or more years, and drops down two notches in its rating should you switch away from it.
In fact, following a relatively long-period risk-adjusted rating system is the right way to make a decision. So when should investors actually sell their funds? The right answer is that they should be guided by their own financial goals. You should sell a fund and get your money out when you need it.
Let’s say you have invested for five or 10 or 15 years, continued your SIPs, and now the money has grown to what you need. You need to make a down payment for a house, or pay for your child’s education, or whatever else. If you’re getting close to that time, you should sell and redeem, irrespective of the state of the market. In fact, unless it’s an expense that can be postponed if needed, you should start acting one or two years before time. Withdraw the money from the equity fund and start parking it in a liquid fund. You can use an automated STP (Systematic Transfer Plan) for this, which will be convenient.
In a manner of speaking, the primary goal of investing is not to invest but to sell because that’s when you achieve your goal. Be guided by that.
(The author is CEO, Value Research) ……………