Mutual Funds Awareness 103: Why would you want to redeem a mutual fund?
There are three questions that a financial advisors ask the client before collecting money for investments.
- How much money would you like to invest?
- How long would you like to remain invested?
- When would you want to withdraw the funds?
The idea is to understand the customer’s risk profile and determine what products to sell them. A customer who has a longer investment tenure, eg: 7 years or more, could be guided with a 100% equity mutual fund exposure. That is because, irrespective of the current market valuation, an equity fund could stage a comeback even if the market dips in between (provided the economy is growing).
The “tenure” decision gets engraved in the mind of the customer and all they think about is how to redeem it when it is due. The choice of exit is more of an advisor’s recommendation than a client’s need. Does the investor really need an exit? Let us explore more about it today.
Is a mutual fund just another fixed deposit, but one with a higher interest? Does the investor really know what they are getting into??
You know a mutual fund is a basket of stocks, bonds or commodities, but did you really know that owning an equity mutual fund is making you a part business owner?
If you are in India, you might already know a company called RELIANCE. Since it’s listed on the stock market, you can buy its shares and when you do that, you become a shareholder. A shareholder is a part business owner who has the right to enjoy their profits (paid out as dividends). You may not be able to make a management decision to set the price of “Jio recharge” or “Petrochem fibres” as the shares you may hold may not qualify for a “board seat”, but it will never stop you from getting the fruits of their labor.
If you are an employee, you may not really understand the hardships of owning a business. Activities like starting up, raising funds, marketing, sales, customer relations, compliances, taxes, audits and much more, but if you have a good business, it will reward you with lifelong income — either as regular dividends or capital appreciation.
And that exactly is what will happen when you buy a good company’s stock. Even if you are not the one who started that company, you would still continue to get the benefits of dividends or capital appreciation.
If you are selling off the company, it would be like killing the goose that lays the golden egg. Why would you want to do that?
Now, think of what a mutual fund is.
It is an engineered product that buys the best companies. Obviously, a fund manager buys sh*tty companies too, but manages to weed them out with time. I guess, mutual funds should be declared the 9th wonder of the world after “the power of compounding as the 8th wonder.”
In 7 to 10 years from now, your mutual fund holding will have the best companies in it. The ones that make the highest profits, largest sales, and dominate market share. Instead of owning just 1 or 2 companies, you become an investor to 30-50 companies, and when you do — why would you want to redeem it?
Hold on to that thought, because an advisor might have bombarded you with the information that a mutual fund is just a source to multiply your money and I am here telling you, it’s a vehicle to buy good businesses. When you buy, hold onto those businesses for life.
When should you redeem?
The only reason you should be redeeming an equity mutual fund is to invest in another business that has the potential to grow faster. If your MF is giving an average CAGR of 15% for the last 5 years and you know something that could fetch you more than 20%, do not hesitate to redeem.
If you need to park your money for some time, do not consider pure equity funds.
Equity mutual funds are not a speculation tool. Never park your money in an equity fund because you have some surplus now, but you need it back in 6 months. Agreed, many of them are making money by buying today and selling tomorrow — but that’s not the reason MFs were invented.
Introduction to Passive Income.
Equity MFs are the best way to generate passive income. You are becoming an investor in 30 to 50 companies to get their profit share without breaking a sweat. Someone else is doing the heavy lifting, making those tough management calls, selling products, servicing clients and reselling newer products — while you are sitting at home and reading this newsletter and still getting paid.
Just because your goal is achieved, do not redeem.
Make a wise decision once your financial goals have been achieved. Probably you may have 100s of other options to arrange the funds. Let redeeming the MFs be the last resort, as you should know, you are killing the golden goose.
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