Sellers, beware!

The classic refrain of everyone who tries to figure out investing in mutual funds is that there are too many of them, and it's really hard to know where to begin. There are obvious ways around this problem, like advisors or websites or just asking around. However, there's actually an even more difficult choice that investors face, which is at the other end of the investment cycle: which funds to sell off and when.

Strangely, more knowledgeable and more involved investors face this problem a lot more than others. The reason is that those of us who are active and involved investors always have an urge to do something. Such investors generally do well 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.

Most obvious reasons for selling out of funds are not good ones. There are some exceptions, but generally speaking, good reasons tend to be about the investor's own finances and the wrong reasons tend to be about the fund. That may not be clear so I'll explain. Hyperactive 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. 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 in any kind of situation.

Clearly, none of the above reasons are the right ones. 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.

Look at the second point now. Sure, getting rid of poor performers is a legitimate idea, but you do 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, and drops down two notches in its Value Research rating should you switch away from it. In fact, a relatively long-period risk-adjusted rating system like Value Research Fund Ratings is the right way to make such decisions.

So where does that leave us? The right answer is that they should be guided primarily 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 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 if needed, 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.

Think about it. The goal of investing is not to invest, but to sell, to get the money you have earned. That should be given at least as much attention as the first part gets.