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Lock-in period of Mutual Funds

Today an investment portfolio is incomplete without the presence of Mutual Funds. Channelizing amount from numerous investors and investing them into a wide base of asset classes is the most convenient and sensible way to grow your money. Based on this principle, a Mutual Fund invests across asset classes such as equity, debt and other instruments to offer a balanced investment portfolio to investors. Every investor is aware of the benefits of the mutual fund and is increasingly opting for mutual funds to achieve all their financial goals.

The ease of investment, lesser requirement of investable funds, professional management and the benefits of diversification are some of the biggest advantages that Mutual Funds offer.

What is a lock-in period?

Lock-in period in Mutual Funds refer to the period during which the investor is prohibited from redeeming the units of the fund, either partially or wholly. Usually, the lock-in period in case of the close-ended fund is 3 years.

In India, most of the mutual funds do not have a lock-in period. There is only one exception in the category of open-ended schemes, which is the Equity Linked Savings Scheme (ELSS). ELSS are tax-saving mutual funds which have a lock-in period of 3 years. The investments in these funds are eligible for deduction under Section 80C to the extent of Rs 1,50,000.

In case of generic open-ended schemes, if you exit the fund within a year, you need to pay a small fee known as exit load. However, the time period may vary in case of certain funds. After this period, there is no fee levied in case of exit or redemption.

Latest development on lock-in period

As the latest development in the month of November 2018, Securities and Exchange Board of India (SEBI) is planning an imposition of a short lock-in period for investments in liquid mutual funds with an asset base of over Rs 8 lakh crores. Since, there is frequent entry and exit in short-term liquid funds, there is unnecessary volatility and liquidity crisis in the market these days. Expert fund managers opine that the lock-in period of the liquid funds should be just enough to smoothen the volatility, but a longer lock-in period will kill the very essence and attractiveness of the liquid funds.

Why is Lock-In Period important?

During the lock-in period, the investor is restricted from selling the units accumulated. It is done so to check that there is no frequent changes in the number of the units or the overall size of the funds. Too much modification of the fund size or the exit of units has the potential to disturb the stability of the fund.

The Government of India has mandated that funds invested in the ELSS will be eligible for tax deduction. The logic behind doing this is to encourage investors to participate in the equity markets and stay invested for long term to reap more benefits. More investment into the market helps in capital formation, which helps the nation at large.

Mutual fund houses fix a specific lock-in period to hold onto their customers for a long period and to prohibit sales and redemption of the funds too frequently. This is in the interest of the investors so that they have an obligation to stay invested for long-term and they can reap more benefits from equity investments.

What should I do after the lock-in period expires?

Review the performance of the Fund

Once the 3 year lock-in period is over, you must review the performance of the fund. Since, you had only parked money into ELSS for saving taxes should not deter you from analysing how the fund has performed as a whole. Many investors commit the mistake of transferring the money to start another ELSS. If you restrict your objective to just tax-saving purpose, you would not be able to reap the benefits of the ELSS fully.

ELSS or tax-savings mutual fund schemes are invested in equity markets. Even after the expiry of the scheme, you should ideally keep the money invested in it at least for a period of 5-7 years. Equity funds deliver good returns if kept invested for a long-period. A period of just 3 years will not do justice to the equity funds. To review the performance of the fund, you need to assess the historical risk-adjusted returns over the past 5-10 years and also compare it with other funds in the same category.

Treat the investment as another open-ended scheme

You can continue the same investment (ELSS) as an open-ended fund after the expiry of the lock-in period or transfer the money to some other equity based scheme suitable to your objectives.

An ELSS is nothing but a multi-cap equity fund which invests the funds across market capitalisation and sectors. If you stay invested for a longer period, you may observe that the returns generated by these funds have outdone the amount saved in taxes. In fact, in many cases, it has been observed that the ELSS have even outperformed the large cap funds. Being a multi-cap fund, the ELSS also provides a cushion against the volatility.

The Fund Managers too, follow a similar approach to stock-selection as they would in case of any other diversified multi-cap fund.

En-cash the fund

You should not simply exit a fund, just because the lock-in period is over. However, many people redeem their investments after the expiry of 3 years. You do have the option of redeeming your investments after 3 years but you should do so only in case of genuine requirement of funds.

If you are nearing a financial goal, there is a medical emergency in the family or a sudden travel plan, you can redeem only a portion of your investment instead of fully exiting it.

After the completion of 3 years, the ELSS becomes an open-ended fund, wherein an investor can redeem the units as a whole or in lumpsum. There is no exit load or tax levied upon such as exit.

Please note that it is advisable to stay invested in the ELSS and not mandatory to redeem the funds after the expiry of 3 years. However, if your ELSS is not performing well even after a period of 5 years and there is negative returns consistently, you can transfer your investments to a better performing funds. It is your money at the end of the day and you must take prudent decisions regarding it.

Frequently asked Questions

(1) What is a lock-in period?

Lock-in period is a specific tenure during which investors are prohibited from selling their mutual fund units. The tenure of lock-in period in most cases is 3 years.

(2) Do all mutual funds have a lock-in period?

Most mutual funds in India do not have a lock-in period. Only, ELSS or the tax-saving mutual funds have a lock in period of 3 years.

(3) Is it mandatory to stay invested or withdraw funds even after the expiry of lock-in period?

No, it is not mandatory. After the expiry of the lock-in period, ELSS becomes like any other open-ended equity fund. You are advised to stay invested, however, you can also choose to partially or fully withdraw your funds.

(4) Why is a lock-in period imposed on ELSS?

Lock-in period is imposed to make in mandatory for investors to reap more benefits out of equity investments and also maintain stability of the fund. A minimum tenure of 3 years is the least amount of time that the funds must stay invested in the equity market.

(5) What is the tax rebate that is available on ELSS funds during lock-in period?

You can avail a tax deduction of Rs 1,50,000 under section 80 C once you invest in an ELSS fund.

(6) Do I need to invest in lumpsum for an ELSS fund?

No. You can invest in lumpsum or through SIPs with an amount as low as Rs 500.

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