Shilpa Bhaskar Gole, Founder & Chief Financial Wellness Coach, NerdyBird Financial Wellness, says “when you are reviewing your portfolio, what are some of those reasons which could lead you to having an exit strategy? I find in my area of work that there are four or five typical reasons why people will want to exit from the mutual fund. One question that I get asked most often is, I am invested for a long-term goal. You were also mentioning mutual fund as a long-term strategy. When is a good time for me to get out of this mutual fund and redeem my amount? That is number one.”
Do you come across a question where people ask you how one should exit a fund or if that even exists as a concept when you talk about investing in a mutual fund?
A lot of my clients ask me this question around exiting mutual funds. I think the first assumption that one must have is that you are talking about people here who are reviewing their portfolio on a regular basis and are reviewing it from the perspective of goal-based asset allocation. We are saying that whatever mutual funds you have in your portfolio are there to help you accomplish your goals. With that assumption in mind, a lot of clients come to me with that question. What we look for is what these exit cues are.
When you are reviewing your portfolio, what are some of those reasons which could lead you to having an exit strategy? I find in my area of work that there are four or five typical reasons why people will want to exit from the mutual fund. One question that I get asked most often is, I am invested for a long-term goal. You were also mentioning mutual fund as a long-term strategy. When is a good time for me to get out of this mutual fund and redeem my amount? That is number one.
The second important exit cue and exit strategy that people would want to have around is when they are over-diversified. Very often people come to me with 15 and 20 mutual funds in their portfolio. Then the question is what do I remove from this portfolio and how do I exit some of these poor-performing funds?
The third cue is very often in terms of asset allocation. Very often I find that there are people who are very aggressively investing in equity, which is great for a long-term goal but what happens because of that often is there is a lot of concentration towards equity in their portfolio. Even from a rebalancing point of view, an exit strategy is very important for clients. These are the top three reasons that I find very often.
Some of the less proactive reasons where people are more reactive are around emergency fund. Suddenly people say that I have all my money in equity mutual funds, now I have an emergency and I need to remove some of this money. Can I exit from this mutual fund? That is also a reason that I find coming up.
We are also talking about the mutual fund universe where we have mutual funds specific to different categories, different sectors and themes. An exit call would depend, apart from all these three factors, sector-specific or theme-based mutual funds. How can one plan an exit strategy based on the kind of category a mutual fund belongs to?
When we talk about the category, let me start by talking about equity in particular because most people look at a long-term strategy with a lot of equity concentration in their mutual fund portfolio. When it comes to equity, it is very important that, especially when you are thinking about long-term goals, you want to exit as soon as you have 2-3 years left approaching your goal and there are just 2-3 years to get there. That is number one.
The other way to look at it is to say that I have created an adequate amount for this goal and I have reached my target, I have completed the goal amount, so I exit. When you are doing this exit, what can happen in equity is that there is a bear run going on and at that phase you start getting jittery, should I remove my money or not? But here the important assumption is, especially when it comes to equity and long-term investing, that you have already been invested in this fund for at least 7-10 years.
So what we are hoping for you is that if the quality of the fund is good, you may have already seen a lot of upside and if you have already reached your goal, it is okay for you at this point to start exiting from this fund.
Now what if you are in a bear run? I think if the goal is negotiable, then you may want to wait out the bear run and then again start to withdraw this through a systematic withdrawal or through a systematic transfer plan into a safer instrument like a debt fund or a savings account. So that could be a strategy that you have around equity.
Around debt, I find that having a strategy around timing is not really important because these are mostly instruments which are way safer. If you are looking at something where it is a target maturity fund or a medium duration or a long duration fund, then definitely you would want to wait out for the entire period of the term of that particular fund because of the kind of bonds that they have invested in because if you wait out for the entire duration of the fund, then the interest rate risk really comes down for you.
So I would suggest that if it is bonds, then wait out for the entire term and then exit from that debt fund. In terms of equity, if you can wait out a bear phase and then start redeeming from that fund, well and good for you. If you hit your target, it is a good time for you not to over think it and start taking the rupee cost averaging and do a systematic withdrawal and start phasing out your withdrawals. But go ahead and start withdrawing the amount from your equity fund.
Also when you are looking at an exit strategy, what kind of tax implications one should be kept in mind?
When it comes to exit strategy and tax implications, whether you are redeeming this money into your savings account or whether you are doing a systematic transfer plan or a systematic withdrawal plan, it will be charged to you as a redemption and that is very important for you to remember. Now when it comes to equity, it is important for you to remember that if your holding period in this mutual fund is less than one year, then you will be charged the short-term capital gain rate of 15%. Anything beyond a year, then the first 1 lakh of your capital gain will be totally free of tax and everything beyond that will be charged at 10% long-term capital gains tax.
When it comes to your debt funds, we are looking at any fund where the equity exposure is anything less than 35%. It could be 100% debt or it could be less than 35% equity. In such funds, whether you hold it for a short-term or long-term, you are going to be charged as per the slab rate that you come under for your income tax. I think it is important to also mention that there is a category which is somewhere in between right now, which is your category where your equity is less than 65% but more than 35% in a fund.
So there you are still looking at getting the indexation benefit for anything if your holding period is more than three years along with a 20% flat rate. So three years and beyond, indexation benefit and 20% flat tax rate. Anything less than three years and you get taxed as per the slab rate.
So in order to arrive at a decision where you should be exiting a fund, it is very important to keep reviewing your mutual fund portfolio or for the entire financial portfolio if you have not invested in mutual funds. How important is tracking your portfolio and how often should you do it?
Tracking your portfolio is extremely important and as often as you can do it. There are some people who like to do it once a month and they feel comfortable with that. But I would say at least once in six months, look at your portfolio to see what is happening with the different funds because if you are looking for underperformers, you want to at least track them for a 24-month period before you make up your mind on whether to keep it or to drop it.
It is very important that every half year at least you are looking at your funds and reviewing them carefully based on all the different parameters.
