Mutual Fund Redemption

Redemption of mutual funds is possible at any time except in a few schemes, which have a lock-in period. Those selected schemes redeem after the completion of lock in period. It is a proven fact that a long-term (more than 5-7 years) investment in mutual fund gets the best out of your investment. However, often, there arise certain situations like need for rebalancing of portfolio, change in investment objectives, sudden calamities, etc. which leads to need of redemption.

Redemption is an important decision and it should be based on meticulous analysis of one’s own personal requirement, financial goals and not on investor’s sentimental decision or just because market is jittery.

What is mutual fund redemption?

Redemption is a simple process of selling shares or units back to the fund. In short, you can withdraw your units and get the money back at the net asset value prevailing on that day.

Why investors redeem mutual funds?

There may be various reasons for an investor to step up for redemption

   1. Overestimated risk taking ability

Investors often over estimate their own risk taking ability looking at historical returns. Often the risky funds that give high returns have long period of low or negative returns as these funds invest in volatile underlying and fund manager takes risk to get high rewards. Investors who are unable to see low returns and get panic may think for redemption.

   2. Market is high – book the profit

Every time, a high market cannot be the reason for redemption. You cannot time the market for each investment. Your financial advisor will be the right person to book profits and cut losses. Opting for redemption when the market is high majorly depends upon the objective and financial goal as well.

   3. Unexpected market meltdown

Due to financial crisis, often the market faces a massive fall. The falling market graph worries investors and the investors think redemption will secure the remaining investment amount. The funds, which invested with a specific objective, are not advisable for sell.

Why mutual fund redemption is not advisable when the market is low?

Various reasons contribute to the sudden meltdown of market. For instance, at present, due to coronavirus pandemic, the Indian stock market is witnessing massive falls. The mutual fund investors worry about seeing their investment in negative value due to massive cut down in Net Asset Value within a short period.

In this situation, investors, especially those bearing a low-risk appetite, go for redemption or stop their regular SIPs. It is a common and natural behaviour among investors during such market turmoil. How far is this decision correct for the investors to stop further losses? Instead of turning to redemption or stopping the regular SIPs, it is advisable here to understand the implications of redeeming or discontinuing SIPs.

Should the investors redeem the mutual funds when the market is down?

Redeeming your equity stocks when the market is low will only result in permanent losses. Equity mutual fund investments are for long-term. A few irregularities (market volatility) are very much a part of the journey. Therefore, during such times, it is advisable to stay calm and think of ways to deal with the situation. By sticking to your original investment plan, you give time to the market and your funds to recover.,

The SIP route is better

When the market is low, it is always a good idea for an investor to take the SIP route. If you are systematically investing in mutual funds, consider paying SIP regularly and do not stop it midway. You will benefit with additional units. SIP model allows investors to purchase more units when NAV of funds are lower. More the number of units you accumulate higher will be fund value when NAV rises in a high market.

Using the SIP route, you do not need to time the market. Whatever, the market conditions could be, high or low,you will be benefit in either case.

Benefit from the lower NAV

The mutual funds follow the principle of rupee cost averaging. The number of units purchased depends on the existing Net Asset Value. An investor can purchase a high number of units at lower NAV if planned for a long-term investment.

Suppose, if you have 1000 mutual fund units, costing Rs. 500/- per unit. As a result of a sharp fall in the market, the present NAV is Rs. 400/- per unit. In this condition, you might sell the units to save further loss. Here, it is probable that you will lose Rs. 100/- per unit. On the other hand, keeping in mind the benefits of long-term investment, instead of selling, you can buy more units; say 1000 units costing Rs. 400/- per unit.

Purchase price of units:

As you decided to sell the units at low NAV i.e. 400/-, lets calculate the total price of the units.

From the above table, you can see a total loss of Rs. 1, 00, 000 if you sell the units during the market meltdown.

Instead of selling, you opt for purchasing some more units, say 1000 units at Rs. 400/- units. Your total investment is Rs. 9, 00,000.

Now, again when the market faces the bright side and the price per unit rise to Rs. 600/- you can sell the units and earn profits.

Selling price of units:

From the above table, we can conclude that avoiding redemption during low market, holding the units and adding more to it provides additional benefits when the market recovers.

In short, when the price of equity falls, don’t panic, but discuss your fear with your financial advisors and invest more because the redemption in low market may turn the notional loss into permanent loss.

The market fluctuations will always be there for one or the other reason. The risk in the equity market is always higher but so are returns. Some might like to step out and re-enter the market later, but it might only result in hurting your capital.

It is observed from past market history that whenever the market has fallen sharply, it has also provided a golden chance for the long-term investors to benefit them similar to the present situation using mutual fund SIP route.

Who should redeem during a low market?

A downturn in the market is not a reason for the redemption of mutual fund units or stop regular SIP. In other words, it can turn out to be a bad idea to redeem during a massive fall. Ideally, the mutual fund investors should give the scheme at least 3-5 years to perform.

However, there arise certain situations when redemption decision counts favourable. For instance, if your mutual fund schemes consistently happen to underperform its benchmark over 3-4 years, you can take a closer look at schemes you invested in and move to other schemes, which show better performance.

Secondly, redemption option seems meaningful when you are close to achieving your financial goals within 2-3 years in case of market crash. During a financial crisis, it is not feasible to time the market.

Timing the market

During the market crisis, “How long will the market continue to fall?” and “When will the market recover?” these are the two major queries that hit every investor, including the long-term investor who has experienced the market disasters before.

Practically, if you think, it is not feasible to predict the behaviour of the market on any particular day. There is no calculated strategy to time the market and decide for the investors when to make investments.

During market disasters, investors often tend to behave like traders. The long-term investors can’t afford to get in and out of the market frequently. The fall in NAV of funds spread fear among the investors. It is always a good idea for mutual fund investors to stay focused on their goals and stick to their investment horizon.

Redemption process

Redemption can proceed on any business day through either offline or online process. It is imperative to note that the price of funds units are fixed only once a day. The redemption request can be forwarded before the financial market closes down or when the fund house has marked its time. The units will be redeemed at the net asset value (NAV) on that particular day. On average for equity mutual fund within 3-4 business working days, the amount gets credited in the account.

*NAV = (Total Asset- Total Liability) / Total no of units outstanding

What is redemption fee or exit load?

The redemption fee is levied on the investors as the charges or fees need to be paid to redeem or sell the units. It is also known as exit load.

Other names of redemption fees are market-timing fees and short-term trading fees. The redemption fees also encourage investors to hold the units for a long term.

It is imperative for the investors to have clear understanding about exit load or redemption fees to calculate the exact amount they would be entitled to receive after redemption.

The redemption fee is levied to compensate for the short-term trading of securities. It helps the mutual fund companies to mitigate transactional costs.

This encourages the investors to hold the units for a long-term. To note down, exit load or redemption fees are not included in an expense ratio. The expense ratio is charged to manage the expenses raised in managing the investments.

Mostly, the redemption fees amount is up to 1% or 2% of the transaction amount.

Similarly, the time period also varies in redemption. The different time periods are 30 days, 90 days, 180 days, or one year.

Calculation of exit load

Suppose, an investor invested Rs.10, 000 in a mutual fund scheme in January 2000. The NAV of the scheme is Rs.100. In June 2000, the investor would opt to invest Rs.2, 000 at NAV of Rs. 100 in the same fund. 1% is the total NAV is charged as an exit fee.

Let us calculate the exit fee if he redeems the fund in November 2000, when the NAV is Rs.110

For redemption in November 2000, the exit load would be charged for both investments in January 2000 and June 2000 as per the prevailing NAV of Rs.110 in November.

Calculate the exit fee, if the redemption happens in February 2001, when the NAV is Rs.115.

In the case of redemption in February 2001, the first investment of January 2000 passes the one-year term. Thus, exit load is not charged on the first investment.

To Sum Up

Unless you have unavoidable reasons to redeem mutual fund units or you are nearing your financial goal, there is no real need for redemption.

Mutual Funds offer highest return if held for long period like 5-7 years. Mutual Fund as an asset category offers highest cost effective liquidity amongst other assets like Real Estate, Gold Jewellery or Fixed deposit. Unless you have fund requirement or you are closer to reaching your financial goal, do not opt for redemption before the predefined period.

Money not redeployed is often money lost after redemption.

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