How to determine when to exit a fund?

The long-term benefits of invest in equity mutual funds are legendary and well demonstrated. Yet, there are instances when doubts creep in. There are times when other funds do better. The tax implications of exit can be confusing and also whether to exit completely or use the systematic withdrawal option are all the doubts that crop up. Here are some instances which could be considered when deciding on exiting an equity fund in which you have SIPs.

Management and style: Change in fund management by way of fund manager exit or the fund merging into another scheme from the same AMC. These days several AMCs are being sold or merging with others. These are all instance to consider when change in management of the fund. There are times when a fund’s management style may change, which may no longer be in sync with your expectations or risk profile. Such instances are a good exit trigger. 

Performance: There are times when the fund’s performance dips consistently. Such an instance should be used to evaluate its presence in your portfolio and considered as a trigger to exit from it. But, don’t let one month of bad performance make you change your mind. Ideally, check for how the fund is faring compared to the benchmark and also its peers. Give it a couple of quarters before considering an exit.

Rebalancing: Instead of exiting a fund blindly, check how its performance is impacting your asset allocation, the debt to equity allotment. If there is a sudden change in market conditions and the allocation gets skewed, it’s time to sell some units to rebalance the portfolio. Or, it could be just an annual rebalancing exercise, which could result in exiting the investments in a fund partially.

Goals and needs: If you are close to the goal you are investing in or need money for any other reasons, you could consider selling the fund. For instance, you started investing in 2010 with the goal to reach Rs 10 lakh sum in 2018, but by end of 2016, your investments have grown to Rs 10 lakh. With over a year to go for your goal to be achieved, it makes sense you exit the investment and put the Rs 10 lakh in a liquid fund till such time you actually need it.

However, if you were investing for your retirement, which is due in July 2017, you should not exit investments in a lump sum; you should start systematically withdrawing your money now onwards. The reason for this move can be understood by those who recollect the 2008 financial meltdown, when the market lost over 50 per cent of its value in a single year. So, withdrawing money earlier on is a good way to protect you from market gyrations. So when the market is on a high and you are approaching your goal, start a systematic withdrawal plan (SWP) where units are sold and the money is either channelized into a liquid fund which are more tax efficient than a ban deposit.

Profit booking: Well, it is not a good move, especially when investing for the long run by way of an SIP. The beauty of SIP is that you average your investments in the fund, which means you buy more units when the market is down than when it is up for the same sum being invested. Systematically booking profits defeats the purpose of an SIP. Instead, consider withdrawing when closer to the goal or year of goal.

The other aspect that tends to confuse is the tax implication when exiting an equity fund. If you invested in a dividend option, your dividends would be tax free. If you sell your units after a year of holding, you pay no long-term capital gains tax. However, if you sell units before 12 months of holding, you pay short-term capital gains tax and taxed accordingly. The capital gains calculation is done on when the SIP was made and is based on the principal of First-In, First-Out (FIFO). So when you sell units, the fund house will redeem the units you obtained from the first SIP onwards.