Investors' Hangout: Deciding to divest-When should you sell your mutual fund?

What are the reasons that usually prompt investors to sell their investments?

Anything can prompt an investor to sell. If someone's investment is doing very well, and the market goes down, it could prompt them to sell. The market goes up, and they think they must sell before the market crashes and they lose the opportunity. Sometimes people get bored; they invest, nothing happens, the value goes up a little, comes down a little, and they think they must sell because nothing significant is happening. Interestingly, many investors also ask if they should sell when the lock-in period of their fund is over.

People often think they need to do something with their investments because they are used to fixed-term deposits with a start and end date. They think investments work the same way. But with open-end mutual funds, you put your money in, keep adding more, and it keeps compounding. The fund manager is doing the necessary work, moving money from expensive stocks to cheaper ones (hopefully), and hence you don't need to act. This whole process is very tax-efficient, too.

Are these reasons justifiable enough for one to sell their investments?

These reasons often tempt uninitiated or relatively new investors to act based on preconceived notions about the market. These are absolutely not valid reasons to sell. Following these reasons can be a recipe for disaster. Long-term investing, especially in equity through SIPs in mutual funds, is an act of discipline. You don't get rewarded for simply choosing a mutual fund; you get rewarded for disciplined investment over time. Markets are unpredictable in the short run, but they generally go up in the long run.

When is the right time to sell a fund?

There are only three primary reasons to sell a fund:

1. Meeting a goal: If you invested with a specific goal in mind, like buying a car in three years, and the money has appreciated earlier than expected, it's a good time to sell and take your money out.

2. Change in plans or circumstances: If your goals or circumstances change—like losing a job or needing money for something more important than the original goal—it's a valid reason to sell.

3. Deterioration of investment quality: If the fund or company you invested in loses its desirable features—such as a change in the fund manager, poor performance without signs of recovery, or losing confidence in the investment—it's time to sell.

No external factors like global financial crises, wars, or market volatility should be reasons to sell. Markets fluctuate daily, but this is not a valid reason to sell your investments.

In a typical 20-30 year investing lifespan, there will be a few occasions when the market will decline dramatically, testing your nerves. Markets can drop by 40-60 per cent, and these declines often happen suddenly, while gains accumulate steadily. This can be unnerving even for seasoned investors. New investors, especially those who started SIPs in the last five to seven years, may panic and sell during such declines, like the one in March 2020.

At times, if a business is under scrutiny for some reason, that's also another pointer that triggers the sell decision in investors. So is that a good enough reason?

Yes, if you discover that a company or fund is not as good as you initially thought, or it's not performing well, it's a valid reason to sell. However, verify the information because sometimes good companies can also get bad press, which may not be true. Don't act in haste. Selling your investment triggers taxes. Additionally, taking your money out and waiting for the right time to reinvest can result in idle money, missing potential gains.

Therefore, avoid impulsive decisions, stick to a plan and ignore insignificant factors. Build shock absorbers into your equity or mutual fund portfolio by diversifying. Ensure no single investment is too large a percentage of your total portfolio. This way, even if one investment fails, it won't significantly impact your overall portfolio, allowing you to continue benefiting from other investments.

Viewer's question

S B Joshi asks, "The rates of interest on deposits are not likely to go up any further. So, is it a good idea to shift existing deposits to mutual funds?"
I would like to give a framework to Mr Joshi. Predicting interest rate movements—whether they will go up or down—is very difficult. Over the past four to five years, I've found that my guesses and those of many fund managers have often been wrong. Assuming Mr Joshi's hypothesis is correct, he still shouldn't base his investment decisions solely on interest rate predictions.

Invest your long-term money in equity and your short-term money in debt funds. This decision should be guided by your financial goals, not by the state of interest rates or the market.

1. Short-term needs: The money you need in the next two to three years should be kept in deposits or debt funds. This ensures stability and availability when you need it.

2. Long-term investments: Equity investments should be the money you won't need for the next five to 10 years. However, even if you have a significant amount to invest in equity, avoid putting 100 per cent of it into equities. After accumulating a substantial amount, ensure you have 20-30 per cent in fixed income to act as a shock absorber. As a result, your overall portfolio remains stable during market downturns. Additionally, rebalance your portfolio when required.

Click here to register for the next episode of Investors' Hangout.