Equity mutual fund investors often attempt to time the market. This strategy involves waiting for market declines to purchase shares at lower prices, with the intention of maximizing profits by selling at higher prices. While the principle of buying low and selling high is widely regarded as the optimal investment strategy, its execution is considerably challenging.
The stock market is inherently volatile, making it difficult to accurately identify the lowest and highest points. Occasionally, as the market reaches new peaks and stock valuations rise, some investors may feel compelled to realize their profits. While this approach is not inherently flawed, adhering to fundamental investment principles can be beneficial. It is essential to adopt a prudent strategy regarding the sale of mutual fund units or the decision to exit investments.
For mutual fund investors, there is no definitive moment deemed ideal for exiting. The notion that one can time the market implies the ability to predict optimal exit points, which is generally discouraged. It is advisable to adhere to the well-known principle of remaining invested in the market over time. Nonetheless, there may be legitimate circumstances that necessitate accessing funds from the market. Let us examine some of these situations.
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Are your goals approaching?
If your financial goals are approaching, it is prudent to transition from equity funds to less-volatile liquid funds through a process known as de-risking. For long-term objectives, such as funding education or retirement, it is advisable to divest from equity funds well ahead of the investment horizon, ideally two to three years in advance. Even if there is a slight shortfall in returns of approximately 6-7%, liquid funds can effectively bridge the gap for the remaining duration of your investment timeline for these goals. Short-term objectives or those that are imminent should be directly addressed with liquid mutual fund investments, rather than being left vulnerable to the fluctuations of equity markets.
Fund Performance
It is essential to conduct regular evaluations of your mutual fund scheme’s performance. While certain funds may consistently exceed expectations, many actively-managed funds may underperform relative to the market or their benchmarks. If, during your review, you identify underperforming funds within your portfolio, it may be prudent to consider divesting from them.
In some cases, selling a mutual fund may be more critical than the initial purchase of that fund. This situation often arises when there are fundamental issues affecting the fund’s performance over time. Engaging a financial advisor during this process is advisable, as a timely exit from an underperforming fund or a strategic entry into a more suitable fund can facilitate effective portfolio reallocation and restructuring.
Avoid redeeming for discretionary expenses
The open-ended structure of mutual funds can tempt many investors to exit their investments easily. It is common for some individuals to sell mutual fund units to cover discretionary expenses, a practice that should be avoided. Whenever possible, mutual funds should be sold only to address essential needs or priorities rather than luxury expenditures, particularly when other significant financial objectives are on the horizon.
Reassess risk tolerance
Choosing a mutual fund scheme that aligns with one’s risk profile is crucial. If you find that your investment decisions regarding mutual funds do not meet your expectations—whether due to debt or equity exposure—or if the associated risks feel excessive, it may be wise to consider reallocating your mutual fund units to options that better match your risk tolerance and financial needs. Conversely, one might also contemplate shifting from debt to equity investments.
What to do?
In times of market decline or perceived weakness, it is common for investors to liquidate mutual fund units and halt their systematic investment plans (SIPs). However, historical trends indicate that such downturns are often temporary. Remaining invested is generally more beneficial than attempting to re-enter the market after it has begun to recover. As an investor, it is advisable to utilize a SIP calculator to determine the amount necessary to save in order to meet the inflation-adjusted costs of your long-term objectives, and subsequently allocate funds accordingly. Market declines can present an opportunity to acquire additional units.
Short-term fluctuations in equity markets can also serve as a chance to invest, provided you have surplus cash available. In this context, it is crucial not to compromise other financial goals, such as your emergency fund, which should be adequate to cover your monthly expenses for at least six to nine months.