Redeeming investments is an important part of investing, but one that investors don't give enough attention
20-Feb-2017 •Dhirendra Kumar
Disinvesting is the most important part of your investments. That sounds illogical but isn't, even if you are not the Government of India. Think about it. The goal of investing is to grow your money. However, this goal is accomplished only when you have taken the money out of your investments and taken it back in your bank account. Therefore, it should be self-evident that the manner and timing of redeeming your investments is an important--in a way, the most important--part of your investments.
Of course, this is not actually true for assured or almost-assured savings like PPF or fixed deposits. Nor is it important for those who are dabbling in stocks and derivatives for short-term punting. However, having an exit strategy is crucially important for those who are investing long-term in equity-backed mutual funds for meeting the financial goals of their lives. There's a huge amount of money that now flows into equity mutual funds through SIPs (Systematic Investment Plans) every month. Currently, this is a humongous Rs 3,000 crore a month. Typically, these investors are investing this money for a specific life goal, which could typically be a house, education, retirement or something else.
SIPs through equity funds offer far higher returns than fixed-income options, enabling investors to meet these goals. Investing gradually means that investors are protected from most of the effects of equity volatility while they are investing. However, the invested amount obviously goes up and down as the equity markets continue on their way. As is the way of equity, the underlying rate of return may be good, but it's hidden behind larger month-to-month and even year swings. This is a problem when one is investing for meeting a particular financial goal. It's entirely possible that just when the time comes for you to withdraw the money and use it for the purpose for which it was meant, it's value is reduced by 10 or 20 per cent, or even more.
So what should you do about it? How can you protect yourself from falling short of your goal? The answer is quite straightforward, but one that's rarely discussed by financial advisers. The way investors overcomes volatility (in fact, turns it to an advantage) by using SIPs while investing, they must use SWPs or STPs (Systematic Transfer or Withdrawal Plans) while redeeming their money. The idea is very simple. About 12 to 18 months before you need to use a certain amount of money, start moving it to a stable debt fund category, or to your bank account. Do it in equal monthly installments. This doesn't take any great effort--all you need to do is to give the mutual fund a single instruction for the entire period and a fixed amount will be either redeemed or transferred to your bank account every month.
This will effectively mean that the exit value you will get is an average across that entire period. That's the whole point of this exercise. In case the markets fall just before the time you actually have to use the money, you're still OK because a good part of the money has already been redeemed. At worst, the drop in value will affect a smaller part of the total funds withdrawn.
Of course, you must also be aware of the flip side of the coin. It's entirely possible (in fact, likelier) that this exercise will actually reduce your returns. If equity values rise during the period, then the average you will realise will actually be lower than the value at the end. This is a classic conundrum and a reverse effect of what happens in an SIP. What you do about it just depends on what you need the money for. If the need can be postponed for a year or two, then you can just wait. Otherwise you should follow this safe exit plan.
A special case of this withdrawal problem is for retirees or anyone else who needs a regular income from investments. The basic principle remains the same--money should be moved to a less volatile investment a year or so before it's to be used.