Perhaps the most crucial concept any first-time investor entering the mutual fund (MF) industry should learn is when and how to make a graceful exit. Choosing the right time to exit a scheme is a critical decision that requires extensive research.
Often, investors make this decision based on their sentiments if they feel a fund is underperforming or the market is too unstable. However, that’s not the best way to go about it. That’s because even uncertain markets can carry some opportunities that might give good returns. So, what is the right time to redeem MFs and how to do it? Let’s find out.
When an investor sells or withdraws their fund units to obtain returns, it is called mutual fund redemption. Simply put, it is the act of exiting an MF scheme and redeeming the units you hold. Redeeming mutual funds provides you with an exit route from the investment and gives you the present value of the investment in terms of monetary returns.
You can either redeem units in parts or exit fully. There are 3 major types of redemption you can opt for:
Additional Read - How To Invest in Index Funds in India – All You Need to Know About Index Funds
Here are the types of mutual fund redemption:
1. Unit-based redemption
The investor specifies the number of units to be redeemed. The amount received is based on the current Net Asset Value (NAV) of these units.
2. Amount-based redemption
The investor indicates the specific amount they wish to redeem. The mutual fund then adjusts the number of units to match this amount based on the NAV.
3. Redeem all units
The investor decides to withdraw their entire investment from the mutual fund. This method is often used when the investor wants to exit the investment altogether.
4. Systematic withdrawal plan (SWP)
The investor sets up a systematic plan to redeem a fixed amount or a specific number of units at regular intervals, such as monthly or quarterly. This provides a steady stream of income while keeping the remaining investment growing.
Many factors can prompt investors to redeem their mutual funds:
1. Achieving financial goals -
Investors often redeem their funds upon reaching specific financial milestones, like buying a home, funding higher education, or saving for retirement.
2. Handling financial emergencies -
Unexpected situations like medical emergencies, job loss, or urgent large expenses might require immediate access to funds. Redeeming mutual funds can provide a quick source of cash to manage these crises.
3. Dissatisfaction with fund performance -
Continuous underperformance of a mutual fund compared to market benchmarks or other investments can lead investors to withdraw their money. They may seek better-performing alternatives to maximise their returns.
4. Market conditions and volatility -
During periods of significant market volatility or economic downturns, one might choose to redeem their mutual funds to safeguard their investments from further losses.
5. Revising investment strategy -
As investment goals or risk tolerance evolve, investors might redeem their current funds to reallocate their investments.
Picking the right time to redeem an MF is essential. And it all comes down to the investment goals of the investor. You might have invested in a SIPfor 10 to 15 years to fund your child’s education or for a short-term goal like purchasing a car. So, once you get closer to fulfilling your financial goal, consider redeeming the fund units.
Here are a few other valid reasons to redeem your fund units:
The redemption process is simple, depending on the type of MF you hold. You can perform mutual fund redemption online or offline by generating a redemption request. The process can take 5 days or more to get the amount credited to your bank account. Here’s how the online process works:
Step 1: Visit the official website of the fund.
Step 2: Choose the online transaction option on the website and log in using your folio number or your PAN.
Step 3: Next, choose your scheme and the number of units you wish to redeem.
Step 4: Lastly, confirm your transaction.
If you want to go the offline route, you will require a redemption request form. Once you have filled the form, sign it and submit it to the asset management company (AMC) or designated office of the registrar.
Additional Read -What Are Instant Redemption Funds?
To avoid tax on mutual fund redemption in India, you can implement several strategies. Here are some effective methods:
1. Invest for the long term
Holding your equity mutual fund units for more than one year qualifies the gains as long-term capital gains, taxed at 12.5% on gains exceeding INR 1.25 lakhs. This is lower than the 20% tax on short-term capital gains for units held less than one year. Long-term planning benefits from lower tax rates and compounding returns.
2. Offset gains with losses
Use tax-loss harvesting by booking losses in underperforming mutual funds to offset gains in other investments. If you have a capital loss from one investment, subtract it from the capital gains of another, reducing your total capital gains tax. This is useful in volatile markets where some investments might underperform.
3. Systematic withdrawal plan (SWP)
Implementing an SWP allows you to withdraw funds in smaller, regular amounts rather than a lump sum. This spreads out your redemptions, helping manage and reduce your tax liability each year. With an SWP, you can redeem investments systematically, keeping taxable income under control and leveraging the annual tax-free LTCG limit of INR 1.25 lakh.
4. Use tax-saving ELSS
Invest in Equity Linked Savings Schemes (ELSS) to benefit from tax deductions under Section 80C of the Income Tax Act. Contributions to ELSS are eligible for a deduction of up to INR 1.5 lakh from your taxable income annually, reducing your overall tax burden.
Several charges can apply when redeeming mutual fund units, impacting the net returns. Here’s a detailed list of the standard charges:
1. Exit load - This is a fee charged by the mutual fund house when you redeem your units before a specified period, typically within one year of investment. The exit load usually ranges from 0.25% to 1% of the NAV (Net Asset Value) of the redeemed units. It discourages early withdrawal and promotes long-term investment
2. Deferred sales charge (DSC) - Some funds charge a deferred sales charge if the units are sold within a predefined period. This fee typically decreases the longer the units are held.
3. Transaction charges - These are flat fees levied for processing redemption transactions. The amount can vary depending on the intermediary or platform used for the transaction.
4. Redemption fee - Some funds impose a redemption fee, which is usually a small percentage of the redemption amount. This fee is specific to certain mutual funds and is charged when units are sold.
5. Securities transaction tax (STT) - This tax is applicable only on the redemption of equity-oriented mutual funds. The current STT rate is 0.001% on the redemption value. Note that STT is not applicable for debt-oriented mutual funds
6. Tax implications - When you redeem equity funds within one year, you incur an exit load and must pay short-term capital gains tax on your gains. Short-term capital gains tax applies to units held for less than a year. For holdings exceeding one year, long-term capital gains tax is applicable, typically at a lower rate.
Before investing, always check your mutual fund's specific terms and conditions to avoid unexpected costs.
To be a financially sensible investor, you must know when to redeem your MF units. After all, exiting an investment is as critical a decision as entering it. Thus, you require heavy research and a proper evaluation to make this decision.
To make your investment journey easier, download the Moneyfy's mutual fund app by Tata Capital and manage your investments without stepping out of your house!
Investors can redeem their mutual fund investments anytime. However, an exit load may apply if you redeem before a specified period, usually within one year. ELSS funds have a lock-in period of three years.
Redeeming a mutual fund before maturity may incur an exit load, typically around 0.25% to 1% of the NAV. Additionally, short-term capital gains tax may apply if the units are held for less than a year.
There is generally no limit on the amount you can redeem from a mutual fund. You can redeem any part of your investment or the full amount as per your requirements. However, ELSS funds restrict redemptions within three years of investment.
The redemption fee, commonly known as the exit load, typically does not exceed 1% of the NAV if the units are redeemed within the first year of investment. This fee can vary depending on the fund and the duration of the investment.
Mutual fund redemption is taxable. Short-term capital gains tax applies if units are held for less than a year, while long-term capital gains tax applies to units held for more than a year. The rate for long-term gains is generally lower.
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25 October 2024
8 mins read
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