Mutual Funds: Keeping an exit strategy ready is as crucial as making the investment

The important factor in judging the performance of a mutual fund is the investment horizon. One needs to look at longer periods to assess the performance.

Written by Adhil Shetty | Published:September 18, 2015 2:59 am

Investment literature is full of ‘how to buy’, ‘how to invest’, and ‘when to buy’ theories. However, very little focus, if at all, is given to the selling part of the investment cycle. After all, you make money only when you sell. This makes selling as important as making the investment, if not more.

There are four major aspects that help one decide when to sell your mutual funds.

Analyse the past returns of the mutual fund.

The performance of a mutual fund is the most important criteria of an investment decision. If the mutual fund does not perform well, it is time to sell. However, one should be realistic about assessing the performance. The most important way to judge a fund on its performance is to compare it with similar types of funds. For example, a midcap equity fund should be compared with other midcap equity funds. A sectoral fund from a fund house should be compared with other similar sector funds. Similarly, a bond fund or balanced fund should be judged against the performance of other bond funds or balanced funds.

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The other important factor in judging the performance of a mutual fund is the investment horizon. One needs to look at longer periods to assess the performance. For example, many investors invest based on just the one-year performance of mutual funds. Even fund houses and brokers focus on the previous year’s performance. A fund’s supernormal returns in the previous year might have been supported by macro-economic factors that may not reoccur this year. A fund must be evaluated based on 5-10 years’ CAGR. Longer investment horizon minimises the impact of external factors and presents a better picture.

Study the market levels

When the market is at a high, it is time to liquidate an equity mutual fund. One can find out how sustainable future growth is by looking at the overall Price-to-Earning (PE) ratio of the market. PE ratio is a fairly good indicator of the market’s position.

A PE ratio of 22 or higher is a sign that market may not sustain its upward momentum for much longer.

At the same time, it is very difficult to say when the market will start falling from the high. Hence, instead of waiting for the market to touch its peak and get a few rupees more, one should make an exit. It is impossible to time the market.

Many fund houses offer dynamic funds that work on a similar principle. When the market is high, they reduce the equity holding and increase the bond holding. Similarly when market PE is low, the equity holding increases and bond holding decreases.

Monitor the interest rate before taking a decision on bond funds

Bond funds are funds that invest in fixed income securities such as government bonds, corporate bonds, and bank deposit schemes. Return on bond funds is inversely proportional to the prevailing interest rate. When the rates go down, the bonds prices appreciate and vice versa. Hence, in cases where the interest rates have already bottomed out, one should redeem bond funds and find other investment choices unless one is very risk-averse.

Determine whether the portfolio still supports one’s investment needs

Over time, the portfolio may no more be right for one’s investment needs. This happens when the expectation from investment changes and the current mutual fund does not serve one’s purpose anymore. For example, suppose you had invested heavily in equity funds in your 30s. The investment may have given fabulous returns in your 40s too. However, is it wise to remain heavily invested in equity in your 40s? This is a question you have to answer, especially if you cannot afford to take much risk. Hence, this could be the time to sell a few of your equity mutual funds and divert the proceeds to debt or balanced funds.

Careful and systematic investments in mutual funds can yield high returns. However, one must be canny not just while selecting the right time and type of fund to invest in, but also while choosing the right time to exit the investment to get maximum benefits.

The writer is the founder and CEO of BankBazaar.com

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