Most investors spend considerable time and energy selecting the best mutual funds but often overlook developing an exit strategy. Many either hold onto funds indefinitely or fail to review their holdings periodically, resulting in an inefficient portfolio that may not serve their financial goals. While frequent churning a portfolio is discouraged because it increases capital gains taxation implications and transaction costs, understanding when to sell is crucial. Having a well-planned exit strategy ensures your portfolio is not vulnerable to increased risk, and you leave the market at the right time to avoid unnecessary losses.
Common reasons to sell
While investors may be tempted to sell based on market movements – whether during market declines or rallies – these reactions are often counter productive. Another reason is that there is no significant movement in the investment; therefore, they think selling is better. Why do investors do this? It’s primarily because we all have an inherent urge to do something with our investments, and it’s important to distinguish between emotional reactions and legitimate reasons for selling mutual funds.
Here are evidence-based indicators that may signal it’s time to sell:
Persistent underperformance
The most obvious reason to divest is when the fund consistently underperforms its benchmark index over a three-to-five-year period. Short-term underperformance (less than 3 years) isn’t necessarily a reason to sell, as even top-performing funds go through temporary downturns. Compare the fund’s risk-adjusted returns against appropriate benchmarks and similar funds in its category.
Achieving the financial goal
When you reach your investment target, consider securing your gains by moving to more conservative investments. For example, if you’ve been investing for the past seven years to purchase your dream home for Rs. 1 core by 2025. You have reached your goal ahead of schedule, it’s prudent to shift these funds to lower risk investments like short-term debt funds or high-yield savings accounts, regardless of market conditions.
Portfolio rebalancing
Review your portfolio annually or semi-annually to maintain your target asset allocation. For instance, if your original allocation was 65% equity and 35% debt, but market movements have shifted it to 80% equity, you may need to sell some equity funds to restore balance. This systematic approach helps manage risk and maintain your desired investment strategy.
Miscellaneous reasons
Apart from the reasons mentioned until now, here are some additional factors that indicate it’s time to divest.
• The fund manager changes, and you have concerns about the new manager’s record.
• The fund’s investment mandate changes due to the restructuring of scheme.
•The position size is too small to be meaningful in your portfolio, and you don’t plan to increase the weightage.
• The fund company faces legitimate regulatory or operational issues. However, don’t forget to verify the information because even good companies can be under the microscope for no reason.
One thing you must understand is that you should never divest because of external factors. Whether it is market volatility, financial crisis, or wars, these are not reasons to sell. Remember, market fluctuations are common and occur daily. In an investing life span of around 20-30 years, the markets will rise and decline drastically. Even seasoned investors can be unnerved by such volatility.
Avoid impulsive decisions and stick to your investment plan. Your portfolio should have sufficient shock absorbers to withstand volatility. Never allocate a significant percentage of your portfolio to a single investment; instead, diversify.
Successful mutual fund investing requires discipline and a long-term perspective. While it’s important to monitor your investments, avoid making impulsive decisions based on short-term market movements. Regular portfolio reviews (semi-annual or annual) should focus on whether your investments continue to serve your financial goals, maintain appropriate risk levels, and deliver reasonable performance compared to relevant benchmarks.
