Mutual fund investments are always recommended to be allowed to grow for a longer period of time and so, there isn’t any specific time to book profits.
So, right of the bat let’s understand that booking profits doesn’t make sense when it comes to mutual funds’ investments. This attitude only makes investors sell their winners and hang on to losers.
Booking profits doesn’t make sense when it comes to mutual funds’ investments
In mutual funds, the whole point is that there is a fund manager who is deciding for you which stocks or bonds to sell and which to buy. If the fund manager is doing this job well, then the fund is giving good returns.
Therefore, selling a fund that gives good returns could be counter-productive, unless one has achieved a milestone in investment goal and investment cycle.
That being said, if there is ever a ‘right time’ to ‘book profits’ in mutual funds, it is when you achieve your goals.
Therefore, selling a fund that gives good returns could be counter-productive, unless one has achieved a milestone in investment goal and investment cycle.
Compelled to sell?
There are however some instances where it would be unwise to hold onto your investments and situations may arise where you may be forced or compelled to sell to minimize your losses.
You may want to sell and maximise your profits because of several considerations, including a change in your investment goals, consistent underperformance of the mutual fund or the need to offset capital gains against capital losses.
There are however some instances where it would be unwise to hold onto your investments
We explore each of these instances below.
Designed for long-term
Again, when looking at mutual funds as a type of investment, they are designed to be long-term investments. This type of fund is not intended as an investment you buy into and sell out of as the markets move up and down.
Other types of funds - such as exchange-traded funds, or ETFs -- are more suitable for in-and-out investing.
But as part of your overall portfolio strategy, you might experience times when it pays to sell some of a mutual fund investment that has increased significantly in value.
Investment goal met?
If you’re investing for a particular goal - like retirement, your child’s higher education, purchasing a house, etc. - then the right time to redeem your mutual fund investments is when your investment reaches your target amount.
Let’s remember that you need to stay invested in equity mutual funds for a long period of time to get the benefit of ‘Power of Compounding’.
Longer the duration more will be your returns. Unless you require money for your personal reasons financial planners often recommend that you don't abruptly sell and book profits.
Change in investment goals?
Another reason to sell a mutual fund and take the profits is that your investment goals have changed.
For example, you have a stock fund that has performed well and now you want to draw an income from that money.
One option would be to sell some or all of the stock fund and invest in a bond fund that pays monthly dividends.
If you bought an aggressive growth fund when you were younger, you might sell that fund to go with a more conservative fund, such as a growth and income fund.
Funds underperforming?
Another reason to sell would be if the mutual fund is not performing for 2 to 3 years continuously.
If you observe your mutual funds aren’t performing well compared to other mutual funds in same category or that category itself is not performing well compared to the market as a whole - it is then time to take back your money and put it in some other performing funds.
A lot of investors try to sell funds that have performed well but may have under performed other funds by small margins.
Let’s say someone will say that over the last year, my fund has generated 25 per cent but five other funds have generated 30 per cent, so I will switch to those.
This switching based on short-term past performance is counter-productive and does nothing to improve future returns.
So coming back to the point we made earlier, only if a fund underperforms consistently for two or more years should you switch.
Monitoring valuation
Also one frequent reminder for all mutual fund investors given by their advisors is to frequently monitor the market situation.
If markets are much overvalued, then that is another reason it makes sense to move to cash or liquid funds.
Also another indicator to keep monitoring is inflation and how it affects your bond investments.
Higher inflation may force the central bank to be cautious and extend the pause in interest rates, rather than easing rates to stimulate the economy. This will put a cap on further rally in bond prices.
Also, you must know that a wider fiscal deficit—gap in government’s expenditure in relation to its income— implies it is likely to be forced to borrow more.
This is bad news for bond markets as additional supply of bonds will bring down bond prices.
Fund managers recommend sticking to shorter term bond funds for the near term. Shorter the duration, the less susceptible it is to interest rate movements.
Shorter the duration, the less susceptible it is to interest rate movements.
Key takeaways
So to summarise, here are some of the reasons you should consider before taking your money out of mutual funds:
• Reaching the targeted investment returns
• Change in investment goals
• Performance has started deteriorating
• Fund manager changed
• Expenses increased suddenly
• Urgent need of funds
• Overvalued markets
(Systematic Withdrawal Plan (SWP) is a service offered by mutual funds which provides investors with a specific amount of payout at a pre-determined time intervals, like monthly, quarterly, half-yearly or annually.
A Systematic Transfer Plan (STP) is a plan that allows investors to give consent to a mutual fund to periodically transfer a certain amount / switch (redeem) certain units from one scheme and invest in another scheme of the same mutual fund house.)
Both choices of Systematic Transfer Plan and Systematic Withdrawal Plan are tax-exempted.
You will be asked to exercise these options after completing of investment time period of 12 months to avoid exit load. (Exit load is a fee or an amount charged from an investor for exiting or leaving a scheme or the company as an investor.)
Now that we have covered the base of when to, let’s now explore how to go about making the most out of your mutual fund investments.
Both choices of Systematic Transfer Plan and Systematic Withdrawal Plan are tax-exempted.
Fund manager does it all
A mutual fund has a fund manager who actively buys and sells securities for the fund.
It is the fund manager's job to decide when to take profits and what stocks or bonds to buy to replace the sold securities. Fund managers buy and sell to meet the investment objectives of the fund.
If those fund objectives are the same as your investment objectives, the reason for owning the fund is valid, and selling mutual fund shares to take profits goes against your long-term investment objectives.
Reinvesting capital gains and dividends
If, during the course of the year, a mutual fund generates more profits than losses from the securities that were sold, the fund will pay out the net profits in the form of capital gains distributions.
Most investors choose to reinvest capital gain distributions to keep the money working in the fund. But you can elect to have the distributions paid out to you too.
With this option, you will receive profits from the fund each year -- or at least in the good years -- and you can use these for other investments.
Fund manager’s asset allocation strategy
This again is left to the fund manager, and how he or she strategises the allocation of your investment in assets. But it is important to know the strategy to ensure that it is being enforced by your fund manager.
Here is an example:
Let’s say you have an asset allocation plan of 50 per cent each into a stock fund and a bond fund.
If the stock fund increased in value to 60 per cent of your portfolio, you would sell enough of the stock fund and invest the money in the bond fund, so each would again account for half of your portfolio.
