It is common for equity mutual funds to create wealth over the long term and equity MF SIPs typically do so. However, that is an extremely open-ended statement. What does long term mean in this case? Does it mean five, ten, or twenty years? Are there triggers for you to sell your mutual fund holdings in a shorter period of time? Here are a few quick tips.
For equity funds, long term wealth creation should be the driver..
Creating wealth over the long term through mutual funds relies on satisfying certain conditions. It is important to maintain a holding period in your fund investments that allows their managers to fulfil the investment story. A quality business model needs ample time to be reflected in stock market gains, which means fund managers need sufficient opportunity to generate upside. Historically speaking, well-diversified equity funds have generally outshone the index for 5 years and beyond, outperforming other asset classes by a good margin over 10 year spans. To meet your long-term ambitions then, you should plan on an 8-10 year timeframe at least.
For debt funds, the outlook on rates should be your key driver for holding period..
Debt funds are typically characterized by their safety, stability, and liquidity since they are invested in debt instruments. Unlike equity funds, they don’t rely on a longer-term holding. This makes them the preferred option for avoiding the risks associated with wealth creation. Also, the key factor impacting these types of investments is interest rate expectations. Thus, when rates are projected to drop it’s beneficial to maintain your debt fund holdings and conversely when rates are expected to increase it’s prudent to reduce them.
Your holding period is determined by tax considerations..
When it comes to making decisions on holding period for mutual funds, this is a very important consideration. Equity and balanced funds can be heavily affected by STCG of 15% if held for less than 1 year. Therefore, it is beneficial to take advantage of the ability to earn LTCG on equity funds which are tax-free. The same rationale applies to balanced funds as well. In reference to debt and liquid funds, the definition of short term holding is up to 3 year and taxed according to respective peak tax rate. To receive the benefit of LTCG with extra indexation, debt fund investors must align their purchase timing accordingly. Additionally, most debt funds are structured as dividend plans in order to earn tax-free dividends.
Holding period will also be circumscribed by your goals..
Whether you hold equity or debt funds, if you invested in a fund to meet a certain goal, the holding period should be limited to that goal. For example, if you made a 3 year SIP in a liquid fund for mortgage margin money, then that time frame should remain constant. Likewise, if your 10 year equity investment matures in time for your daughter’s tuition fee – again, let the holding period remain consistent. Once your objective has been accomplished and the fund designated for it, don’t deviate from the plan. Otherwise it could impair the discipline of your financial plan.
Finally, it should boil down to a cost benefit analysis..
Your mutual fund holding period must be decided through a cost benefit analysis. First, you need to consider if there are options to place your money in comparable or better investments if you redeem the fund today. Many investors have the tendency to switch their holdings which can incur entry costs for each change of fund; this is something that should be avoided unless there will be substantial long term effects. Additionally, an exit load is imposed on early withdrawal of a mutual fund investment and can range between 1-3%. This can further affect the economics of your investment. Finally, securities transaction tax (STT) is charged at 0.125% when your redemption amount is sizeable or the returns are low which can make a considerable dent in your returns.
