When to sell mutual funds in India is as important as deciding when to invest. While mutual funds are generally seen as long-term investments, holding onto a single fund indefinitely may limit your portfolio’s growth potential. Selling at the right time can help you lock in profits, prevent prolonged underperformance, and align your investments with changing financial goals.
However, selling should not be based solely on market fluctuations or emotions. A thoughtful evaluation of your mutual fund’s performance, especially in comparison to its relevant category index, is essential before making any decision. This ensures you identify underperforming funds and retain those with strong growth prospects. In this blog, we’ll explore how to determine the right time to sell mutual funds, the key factors to consider, and practical tips to protect your returns while staying on track toward your long-term financial objectives.
Why Timing Matters in Selling Mutual Funds
Many investors adopt a “buy and hold” strategy, believing that staying invested for the long term is always the best course of action. However, long-term investing does not mean holding onto underperforming funds forever. Mutual fund performance is dynamic, and even popular funds can falter over time. For instance:
Axis Midcap Fund Performance (2016-2023):
Selling this fund in 2021 and investing simply in Nifty midcap index fund would have resulted in a 30% gain, but holding onto it until 2023 would have caused a 30% loss. This demonstrates the importance of reviewing and acting on fund performance regularly.
To determine whether a mutual fund is worth holding, compare its returns with its category index. The index serves as a benchmark, and any significant underperformance signals potential problems. For example:
Bandhan Flexi Cap Fund vs. Nifty 500 TRI
Yearly returns show that the Bandhan Flexi Cap Fund outperformed the Nifty 500 TRI in 2014 and 2015 but started underperforming in subsequent years:
The fund’s performance gap widened to 15% by 2018, making it difficult to recover. If a fund consistently underperforms its category index by more than 15%, it is a clear signal to sell and reallocate your investment.
Examples of Funds That Missed the Mark
DSP Midcap Fund
The DSP Midcap Fund showed early promise but began underperforming in 2017, with a 12% gap compared to the NIFTY Midcap 150 TRI. While it delivered 12.94% returns in 2019, the overall gap remained significant, and subsequent years saw further underperformance.
Selling the fund in 2018 would have saved profits and avoided further declines.
Key Principles for Selling Mutual Funds
When deciding to sell mutual funds, it’s essential to follow a few key principles to ensure your portfolio remains healthy and profitable. First, always monitor performance gaps. While a fund doesn’t need to outperform its category index every year, consistent underperformance is a red flag.
If the gap between the fund’s returns and the category index exceeds 15% and persists for more than 1-2 years, it’s a clear signal to consider exiting the fund. Second, avoid making emotional decisions based on past returns or star ratings.
Historical success doesn’t guarantee future performance, as demonstrated by the Nippon India Growth Fund, which outperformed its index by 130% from 2005 to 2014 but underperformed by 21% compared to the NIFTY Midcap 150 TRI after 2015.
Finally, focus on protecting your profits. Waiting too long to sell can lead to eroded gains. For instance, selling at the right time, as shown with the Axis Midcap Fund, can secure returns and prevent losses. By following these principles, investors can make data-driven decisions that align with their financial goals.
Should I Sell Mutual Funds When the Market is High
While selling mutual funds during a high market can help lock in gains, it is not always the best strategy. In some scenarios, staying invested might be the wiser choice. For instance, if your investment horizon is long-term and your mutual funds align with your financial goals, selling during a high market could hinder your overall wealth creation. Equity markets are inherently volatile, and timing them perfectly is nearly impossible. An example of this is an investor who sold equity mutual funds during the bull market of 2015, missing out on the extended rally that followed in 2016 and 2017. Staying invested would have yielded significantly higher returns over the long term.
Avoid Selling During a Market High
Selling mutual funds during a market high may seem like a strategic move, but it can sometimes lead to missed opportunities for further growth. While locking in gains might feel like the right decision, it’s essential to evaluate whether it aligns with your long-term financial goals. Here’s why holding onto your investments during a market high could be a smarter approach:
1. Selling During a High May Limit Potential Gains
When the market is performing well, mutual fund prices (Net Asset Value, or NAV) are often at their peak. While it may be tempting to sell and secure profits, doing so could prevent you from benefiting from further upward momentum. Markets often continue to rise before hitting their true peak, and selling too early may mean leaving significant returns on the table. For instance, if your equity mutual fund has grown by 20% but the market has room for an additional 10% growth, selling prematurely could cost you these potential gains.
2. Market Highs Are Part of Cyclical Growth
Markets operate in cycles, and periods of high performance are a natural part of this progression. While a market high may suggest overvaluation in some cases, it is not always a signal to sell. Historical data shows that after periods of high performance, markets can often sustain growth for extended periods before entering a correction. Staying invested during such times allows you to maximize returns and capitalize on continued market growth.
3. Stay Focused on Long-Term Goals
Mutual funds are designed to help achieve long-term financial objectives, such as retirement, purchasing a home, or funding your child’s education. Selling during a market high without a clear financial reason could derail your strategy. Short-term gains may feel rewarding, but they might not contribute meaningfully to your long-term wealth creation goals. If your investments are performing well and aligned with your objectives, holding onto them might be the better choice.
Tip: Don’t Redeem Investments Based Solely on Market Levels
Unless there’s a compelling reason, such as a financial emergency or rebalancing your portfolio, avoid selling during a market high. Instead, continue to evaluate your mutual funds based on their alignment with your goals and performance relative to their benchmarks. Selling impulsively during market highs could mean missing out on the compounding effect that drives long-term wealth creation.
When You Should Consider Selling a Mutual Fund
Investing in mutual funds is a proven strategy for long-term wealth creation, but knowing when to sell is just as important as deciding when to buy. Even a seemingly small difference in performance, such as a 2% compounded annual growth rate (CAGR), can create a significant impact on your portfolio over time. For instance, a ₹10 lakh investment growing at 10% CAGR for 15 years becomes ₹41.77 lakh. However, at 12% CAGR, the same investment grows to ₹54.97 lakh—a difference of over ₹13 lakh.
Mutual funds are expected to outperform benchmarks like the Nifty 500 Index consistently. If a fund fails to do so, the compounding effect of underperformance can erode your wealth significantly. Let’s explore when you should consider selling a mutual fund to ensure your portfolio stays on track.
1.Poor Performance
Performance is the most critical factor in evaluating whether to hold or sell a mutual fund. A mutual fund should deliver returns in line with or above its benchmark. If a fund lags behind the Nifty 500 Index by more than 15% in one year or fails to close this gap within 2-3 years, it’s a strong signal to sell. Historical data shows that no fund has successfully recovered from such a significant performance gap.
Why Sell a Lagging Fund?
A consistent underperformance indicates poor stock selection or ineffective fund management. For example, if a fund delivers 5% returns in a year while the Nifty 500 Index grows by 20%, the 15% lag suggests inefficiency. Even if the market rallies in subsequent years, the underperforming fund is unlikely to close the gap.
Actionable Tip: Always compare your fund’s rolling returns with its benchmark. If the performance gap exceeds 15% and persists, it’s better to exit and reinvest in better-performing funds.
2. Changing Financial Goals
As your financial priorities evolve, your investment strategy should adapt too. For instance, high-risk small-cap funds might be suitable during your wealth-accumulation phase but become less relevant as you approach retirement or need stability.
Realigning Your Investments
Suppose you were initially saving for your child’s education and invested in equity funds for high growth. As the deadline approaches, shifting your investments into fixed-income instruments like debt funds ensures capital preservation. Similarly, if your goal shifts from aggressive growth to stability, reallocating from equities to balanced funds can help align your portfolio with your new objectives.
Actionable Tip: Regularly review your financial goals and rebalance your portfolio as needed. Selling funds that no longer align with your objectives helps maintain focus and minimizes risk.
3. Changes in Fund Strategy, Management, or Expense Ratio
Mutual funds are actively managed, and changes in strategy, fund managers, or expense ratios can impact their performance. Additionally, a sharp increase in assets under management (AUM) can dilute returns, particularly in mid-cap or small-cap funds.
Impact of AUM Growth
When AUM grows significantly, fund managers often struggle to deploy capital effectively. This may force them to invest more in large-cap stocks, limiting their ability to generate high returns. For example, a mid-cap fund with ₹500 crore AUM might deliver stellar returns. However, if the AUM grows to ₹5,000 crore, managing the fund becomes challenging, often leading to a decline in performance.
Expense Ratio Changes
An increase in the expense ratio further erodes returns. If a fund raises its fees while underperforming, it may no longer justify staying invested. Over the long term, even a 1% difference in expenses can lead to significant losses due to compounding. For instance, a ₹10 lakh investment growing at 10% CAGR with a 2% expense ratio will yield ₹45.26 lakh in 20 years. However, the same investment with a 1% expense ratio grows to ₹54.30 lakh—a difference of nearly ₹9 lakh
Actionable Tip: Monitor changes in a fund’s AUM and expense ratio. If a fund grows too large or becomes costlier without improving performance, consider selling.
4. Loss of Diversification
A well-diversified portfolio spreads risk across sectors and asset classes. If a mutual fund starts concentrating its holdings in a single sector or asset class, it can increase vulnerability to market downturns.
When to Sell for Diversification?
Suppose your large-cap fund allocates 60% of its portfolio to technology stocks. While this might yield high returns during a tech rally, it leaves your portfolio exposed to sector-specific risks. Similarly, if other funds in your portfolio have grown disproportionately, selling some holdings can restore balance.
Actionable Tip: Review your portfolio’s diversification annually. If a fund becomes overly concentrated or disrupts your overall balance, consider selling.
5. Small Allocation
Holding mutual funds with minimal allocation adds complexity without significantly impacting your portfolio’s performance. For instance, a ₹10,000 investment in a fund within a ₹10 lakh portfolio has negligible influence on your overall returns.
Simplifying Your Portfolio
Small allocations can dilute your focus and make tracking performance harder. Consolidating such holdings into larger, better-performing funds improves efficiency and simplifies management.
Actionable Tip: If you have small allocations that don’t align with your goals, sell them and reinvest in funds that contribute meaningfully to your portfolio.
6.Front-Running by Fund Houses
Front-running is an unethical practice where fund managers or insiders trade securities for personal gain based on non-public information about forthcoming transactions in the mutual fund portfolio. This activity directly undermines investor trust and can significantly impact the returns of the mutual fund.
When a fund house engages in front-running, large-scale transactions by the fund can move the stock prices, allowing insiders to benefit at the expense of retail investors. Such practices compromise the integrity of the fund’s management and create an uneven playing field for investors.
Recent Cases of Front-Running
Several fund houses have faced scrutiny for front-running. For instance:
- Quant Mutual Fund (July 2024): Reports surfaced that insider trading occurred within the fund, raising concerns about their operations and management ethics. This incident led to questions about transparency and accountability.
- HDFC AMC (Past Case): In earlier years, there were allegations against fund managers engaging in front-running, resulting in regulatory actions.
- Axis Mutual Fund (2022): Two fund managers were dismissed after allegations of front-running, causing a major dent in the fund house’s reputation.
Why Front-Running is a Red Flag
When front-running is detected, it raises concerns about the ethical practices of the fund house and its management. Funds involved in such scandals often lose investor confidence and experience outflows, further impacting their performance. Investing in such funds poses a risk to your portfolio, as the fund house’s credibility is compromised.
Actionable Tip: Avoid Funds with a History of Front-Running
Before investing, research the fund house’s track record for ethical practices and transparency. If a fund house is implicated in front-running or similar unethical practices, it’s better to exit or avoid investing further. Look for fund houses with a clean history and strong governance frameworks to ensure the safety of your investments. Additionally, stay updated on regulatory actions and public disclosures to make informed decisions.
Evaluate Carefully Before Selling
Selling a mutual fund is a critical decision that should be based on clear criteria. Here’s a checklist before making the move:
- Compare the fund’s performance against its benchmark and peers.
- Assess whether the fund aligns with your financial goals.
- Consider the tax implications and potential exit loads.
- Evaluate changes in the fund’s strategy, management, AUM, or fees.
Pro Tip: Always consult a financial advisor for personalized guidance. Selling should be part of a broader strategy to optimize your portfolio for long-term success.
Do I have to pay taxes when I sell mutual funds?
Yes, you have to pay taxes when you sell mutual funds, but the tax rate depends on the holding period and the type of mutual fund you own. Whether your gains are classified as Long-Term Capital Gains (LTCG) or Short-Term Capital Gains (STCG), taxes can significantly impact your profits. When combined with underperformance, taxes can erode your wealth and hinder the compounding benefits of long-term investing. Let’s break this down with an example and understand why selecting a consistent, high-performing mutual fund is critical.
Understanding LTCG and STCG Tax Rates
- LTCG (Long-Term Capital Gains):
For equity-oriented mutual funds, LTCG applies when units are held for over 12 months, and gains exceeding ₹1 lakh in a financial year are taxed at 10%. For debt-oriented funds, the holding period must be at least 36 months, and LTCG is taxed at 20% with the benefit of indexation. - STCG (Short-Term Capital Gains):
If equity funds are sold within 12 months, the gains are taxed at a flat rate of 15%. For debt funds held for less than 36 months, STCG is taxed as per the investor's income tax slab, which could go as high as 30%.
Example: Taxes and Underperformance Erode Wealth
Imagine you invested ₹10,00,000 in an equity mutual fund. After holding it for two years, the fund grows to ₹12,50,000, generating a gain of ₹2,50,000.
Scenario 1: Long-Term Gains
In this case, LTCG applies since the holding period exceeds 12 months:
- Tax-exempt gains: ₹1,00,000
- Taxable gains: ₹1,50,000
- Tax liability: 10% of ₹1,50,000 = ₹15,000
Net profit after tax: ₹2,35,000.
The Trap of Switching Funds
Many investors switch funds to chase better returns after experiencing underperformance. However, this creates a vicious cycle:
- Frequent Tax Outflows: Every time you switch funds, you pay taxes on the gains, reducing your investable capital.
- Potential Underperformance of the New Fund: There’s no guarantee that the new fund will outperform consistently. If the new fund also underperforms, you repeat the cycle, further eroding your wealth.
Example of the Switching Trap
- Year 1: You sell an underperforming fund and reinvest ₹9,85,000 (after LTCG taxes of ₹15,000) into a new fund.
- Year 3: The new fund grows by only 8% annually (below your expected 12%), reaching ₹11,45,368. You sell again due to underperformance, paying additional LTCG taxes. Your gains and capital diminish with every cycle, limiting your ability to build wealth.
Why Choosing a Consistent Fund is Crucial
Selecting a consistent, high-performing mutual fund at the outset is critical to avoiding the pitfalls of taxes and underperformance. A fund that consistently outperforms its benchmark allows you to stay invested longer, minimizing tax events and maximizing the benefits of compounding.
Benefits of Staying Invested in a Consistent Fund
- Fewer Tax Outflows:
By reducing the frequency of selling, you avoid unnecessary tax liabilities and retain more capital for growth. - Enhanced Compounding:
Staying invested in a fund that delivers steady returns ensures your capital grows exponentially over time. - Reduced Risk of Underperformance:
A fund with a proven track record of outperformance is more likely to sustain its performance over the long term.
Conclusion:
Selling a mutual fund requires careful evaluation of your investment objectives and current portfolio or fund manager strategies. It’s not something you do impulsively. If the performance of the fund lags significantly or your financial goal changes, you may need to rebalance. Review the fund size, market conditions, and whether funds are diversified portfolios rather than concentrated. A mutual fund may underperform due to poor management or market cycles, so investors must decide to change their holdings wisely. Read all the related documents carefully and consult an advisor before deciding to ensure the asset allocation model supports your goals.
