How To Know When It's Time To Sell Your Mutual Funds?

A common struggle for anyone trying to invest in mutual funds is the overwhelming number of options available, making it difficult to know where to start. There are obvious solutions to this problem, such as seeking advice from advisers, browsing informational websites, or simply asking others. However, there's an even more challenging decision at the other end of the investment cycle-determining which funds to sell and when to do so.

The Problem With Over-Involvement

Interestingly, this problem is more prevalent among knowledgeable and engaged investors. Active and involved investors often feel the need to constantly take action. They typically perform well because they learn, analyze, and act more than others. However, this tendency to equate good investing with constant activity often leads them to be too quick to sell their investments.

Common But Incorrect Reasons For Selling Funds

Most reasons investors have for selling funds are not valid. While there are some exceptions, the good reasons usually relate to the investor's personal financial situation, whereas the bad reasons tend to focus on the fund itself. This distinction might not be immediately clear, so let me explain further.

The Three Common Reasons for Selling

Hyperactive investors give three reasons for wanting to sell off a fund investment:

• They've made profits.
• They've made losses.
• They've made neither profits nor losses.

Someone might say, "Now that my investments have gone up, shouldn't I book profits?" Alternatively, "This fund has lost a bit of money recently, shouldn't I get out of it?" And finally, "The fund has neither gained nor lost, shouldn't I sell it?" Basically, investors with a bias for continuous action can create a logic for taking action in any situation.

Why These Reasons Are Wrong

Clearly, none of the above reasons are the right ones. By themselves, they are not legitimate reasons for selling a mutual fund. The first comes from the spurious 'booking profits' concept promoted by advisers. Booking profits doesn't make sense for stocks, and it makes even less sense for funds. This attitude makes investors sell their winners and hang on to losers.

In mutual funds, the whole point is that there is a fund manager who is deciding for you which stocks to sell and which to buy. If the fund manager is doing this job well, then the fund is giving good returns. Therefore, selling a fund that gives good returns is the reverse of what investors should be doing.

Evaluating Poor Performers

Now the second point. Sure, getting rid of poor performers is a legitimate idea, but you need to evaluate the timeframe and the degree of underperformance. Investors try to sell funds that have performed well but may have underperformed other funds by small margins.

Someone might say, "Over the last year, my fund has generated 25%, but five other funds have generated 30%, so I will switch to those." This switching based on short-term past performance is counterproductive and does nothing to improve future returns. Only if a fund underperforms consistently for two or more years should you switch.

The Right Reasons To Sell

So where does that leave us? The right answer is that investors should be guided primarily by their own financial goals. You should sell a fund and get your money out when you need it. Let's say you have invested for five, 10, or 15 years, continued your SIPs, and now the money has grown to what you need. You need to make a down payment for a house, pay for your child's education, or cover another significant expense.

If you're getting close to that time, you should sell and redeem, irrespective of the state of the market. In fact, unless it's an expense that can be postponed if needed, you should start acting one or two years before the time. Withdraw the money from the equity fund and start parking it in a liquid fund. You can use an automated Systematic Transfer Plan (STP) for this, which will be convenient.

Final Thought

Think about it. The goal of investing is not to invest, but to sell, to get the money you have earned. That should take at least as much attention as the first part does.
In conclusion, while it's tempting to act on impulse and sell your mutual fund investments based on short-term performance, it's essential to focus on your long-term financial goals. Make decisions based on your needs and timelines, not market fluctuations or temporary underperformance. Remember, the ultimate objective is to achieve your financial goals, not just to invest.