Monday, April 23, 2007

When to Say Good Bye to your Mutual Funds? - Part-I

When to Say Good Bye to your Mutual Funds?

A fund once bought cannot be held for eternity. There are certain circumstances that wave a red flag signaling the need to part with your prized possession. They can be those related to you as a person, who has a definite investment objective in mind as well as a certain risk tolerance and of course reasons related to the fund’s management and its performance. I shall take up the ‘you’ related factors in this blog.

First and foremost are the questions - Why did you buy the fund in the first place? What is the time horizon for which it was bought? If it is not fulfilling its purpose or in case it has already fulfilled its purpose, it may be time to sell. In case the appreciation you had expected has happened in a shorter while than expected then it does not matter. Go ahead and sell. In case you had bought for long term so as to cream capital appreciation or for its past dividend record and it has slipped up, then there is no reason for you to hold the same.

Financing a need

We all invest money with a view to financing some need or a desire in the future. Say, you plan to buy a car or a house; or need to pay your child's fees; or maybe you want to take a vacation abroad. All this would require you to liquidate some of your investment. However, proper choice is essential in deciding which fund(s) to sell. You could either sell those funds, whose performance has not been encouraging; or those where the tax impact is minimal; or those where the amounts are not very significant etc. Or sometimes, possibly it may be better to borrow rather than sell a good investment.

Rebalancing the portfolio

We all have a certain asset allocation across various investment options such as debt, equity, real-estate, gold etc. A change in your financial position may require you to rebalance your portfolio. Suppose you are presently having a well-paid job and are unmarried with no liabilities, you can take a much higher exposure in equity funds. But with marriage and kids your responsibilities may increase, which would require you to reduce your equity risk to more manageable levels.

The portfolio balance changes with time, due to different assets growing at different rates. Your equity portion may have appreciated much faster than your debt, distorting the original balance. Hence you would need to sell equity and re-invest in debt to restore the original balance.

A new asset class has been introduced in the market - a capital protection fund or a gold fund - and you want to take advantage of it. You may have to sell a part of your existing investment and re-invest in this new asset class.

A change in your personal circumstances or investment objective. Depending on your investment life cycle stage, in case your long-term goals have now become short-term, shifting assets to more conservative investments may be required. So there is no harm in shifting from equity funds to debt funds. If you are now in a different stage in your life where you are getting closer to retirement, you might want to sell aggressive growth funds for more sedate growth and income funds.

Lastly, if there are changes in your risk tolerance, there is a mismatch between your risk profile and that of the fund. The change in the risk profile could have happened due to change in personal circumstance/fortunes, or due to age, change of job etc.

There could, of course, be other reasons to sell, more specific to one's circumstances. The basic idea is to define, beforehand, certain rules for oneself for selling one's investments. This would reduce the day-to-day dilemma and ad-hoc decision-making, thereby, make investing more scientific and unemotional.

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