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Compared to buying a mutual fund, investors often make worst decisions when it comes to selling them
The fact that there are so many mutual funds in India and choosing a suitable one is difficult is now understood by every saver. Everyone has a way around it, whether it’s advisors or websites or just asking around. However, there’s actually an even more difficult choice that investors face–which funds to sell off and when. Curiously, more knowledgeable and more involved investors face this problem a lot more than others. The reason is those of us who are active and involved investors always have an urge to do something. Such investors generally do well because because they learn, analyse and act more than others. Therefore, they start equating being good investors with doing something, often anything. Unfortunately, along with everything else, in practice, this also translates into being all too ready to sell off their investments.
There are many reasons for selling funds but not all of them are good ones. There can be exceptions but the good reasons tend to be about the investor’s own finances and the wrong reasons tend to be about the fund. Let me explain.
Overactive investors give three reasons for wanting to sell off a fund investment. One, they’ve made profits; two, they’ve made losses and three, they’ve made neither profits nor losses. That sounds like a joke but isn’t. Someone will say, ‘Now that my investments have gone up, shouldn’t I book profits?’ Alternatively, ‘This fund has lost a bit of money recently, shouldn’t I get out of it?’ And finally, ‘The fund has neither gained nor lost, shouldn’t I sell it.’ Basically, what I’m saying is that investors who have a bias for continuous action can create a logic for taking action out of any kind of situation.
And which is the right reason for selling a fund? Obviously, none of the ones above. By themselves, they are not legitimate reasons for selling a fund. The first comes from the spurious ‘booking profits’ concept that advisors have promoted. Booking profits doesn’t make sense for stocks, and it makes even less sense for mutual funds. In both, this attitude makes investors sell their winners and hang on to their losers. In mutual funds, the whole point is that there is a fund manager who is deciding for you which stocks to sell and which to buy. If the fund manager is doing this job well, then the fund is making good returns. Therefore, selling a fund that has made good returns is the exact reverse of what investors should be doing.
Let’s come to the second reason now. While selling underperformers is a legitimate idea, you need to evaluate the timeframe and the degree of underperformance. Investors try to sell funds that have generally excellent performance but may have underperformed other funds by small margins. Someone will say that over the last year, my fund has generated 25% but five other funds have generated 30% so I will switch to those. This switching based on short-term past performance is counterproductive and does nothing to improve your future returns. Only if a fund underperforms consistently for two or more years.
So when should investors actually sell their funds? The right answer is that they should be guided by their own financial goals. You should sell a fund and get your money out when you need it. Let’s say you have invested for five or ten or fifteen years, continued your SIPs, and now the money has grown to what you need. You may need to make a down payment for a house, or pay for your child’s education, or whatever else. If you’re getting close to that time, you should sell and redeem, irrespective of the state of the market. In fact, unless it’s an expense that can be postponed, you should start acting one or two years before time. Withdraw the money from the equity fund and start parking it in a liquid fund. You can use an automated STP (Systematic Transfer Plan) for this which will be convenient.
In a manner of speaking, the primary goal of investing is not to invest but to sell because that’s when you achieve your goal. Be guided by that.
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