They say time is money. That’s especially true with mutual funds. Mutual fund managers pool money from various investors and spread it across stocks from different sectors and in debentures, government bonds, and fixed-income securities. This diversification helps ensure the safety of the capital to some extent. That’s great, but is there a minimum holding time for a mutual fund? How long should you hold for it to be most profitable? If these are some of the questions on your mind, read on.
Holding period for mutual funds
What happens if you invest in a mutual fund but then need to exit suddenly? How long will you have to wait before you exit? Read on to find out.
Minimum and maximum time requirement
The minimum holding time requirement applicable to mutual funds is one day. This is because the fund determines the applicable purchase price of the fund’s units/shares on a daily basis. The price depends on the Net Asset Value (NAV) of the fund as of the purchase date. And to calculate the NAV, the market value of the portfolio is divided by the number of units/shares issued.
As for the maximum period, it depends on the type of fund. There are two types of mutual funds—open-ended and closed-ended. Open-ended mutual funds do not have a fixed maturity period. You can invest in it for as long as you want. Such mutual funds can only close if all the shareholders agree to do so. Closed-ended mutual funds have a maturity date. On this date, the portfolio is liquidated, and the proceeds are distributed to the investors. Of course, the mutual fund company first deducts its fees and administrative expenses from the money.
There is no maximum time requirement for open-ended schemes. The maturity date defines the maximum holding tenure for closed-ended schemes.
Factors that could affect your holding period
There are various factors that you should consider while deciding on your holding period.
1. Taxation structure
The taxation structure basically depends on the two types of mutual funds:
- Equity funds
- Debt funds
Investors who have stayed on in the equity fund scheme for less than one year will have to pay short-term capital gains tax on the profit earned. For debt funds, this tax is applicable where the investors exit the fund before three years. Currently, in both cases, the profits add to the income, which is taxed each financial year.
If investors stay on for one year or more in the case of equity funds, the long-term capital gains tax will be due. There is an exemption on long-term capital gains up to ₹1,00,000. The tax rate is 10% of the amount exceeding this exemption limit without the indexation benefit. (Indexation is a mechanism deployed to take the effect of inflation on prices into account.)
In the case of debt funds, a 20% tax rate applies to investors exiting the fund after a period of three years or more.
2. Market conditions
Unforeseen developments may impact the performance of the fund. If a fund is negatively affected, you may want to cut losses and exit the fund. For example, a change in interest rates can sometimes depreciate the value of fixed-income securities. It makes sense to exit and redeploy the money in such cases.
3. Change in personal priorities
Sometimes, personal circumstances may necessitate an early exit from the mutual fund. For example, you may need to use the money to cover things like medical emergencies.
4. Objectives being met
When the objectives of your investment have been reached, it may make you want to advance your exit. The corpus of fund sometimes exceeds expectations, making investors feel that they no longer need to continue to stay invested.
5. Consequences of early redemption
In the case of closed-ended funds, when investors opt for early redemption before the maturity of the fund, they may have to pay exit fees. They may need to pay anywhere between ranging from 0.5% to 2% of the NAV, over and above the applicable capital gains tax that is due. In the case of open-ended funds, some mutual fund companies levy exit fees if the redemption is within one year of purchase.
Best practices for mutual fund holding period
Relying on best practices while deciding on your holding period for mutual funds may be a good idea. However, the practices that work well vary from investor to investor. Several factors need to be taken into consideration. To determine what are the best practices for you, you could look at the following factors.
Different investors have different objectives and different time horizons in mind. It is always advisable to chart out the type of and level of investment according to your future needs. Are you saving up for a retirement corpus, for building a house, or for higher education? If so, it makes sense to have a multipronged approach and invest in multiple funds with varying maturity periods.
2. Tax benefits
The Indian government offers several tax-saving schemes to help investors reduce their tax burdens. These schemes allow you to offset your taxable income by the amount invested. If you opt for them, there may be a mandatory holding period. Equity Linked Savings Schemes (ELSS), for example, have a holding period of three years.
3. Capital appreciation
In the case of equity mutual funds, the longer you invest, the greater the chance of better returns. Most attractive investment opportunities require a gestation period—the time it takes for the capital to take root and deliver the fruit of appreciation. Fund managers will always keep scouting around for promising options, but investors should also keep monitoring the portfolio. If the performance dips below the benchmark returns, it may be prudent to exit or change course.
4. Interest rates factor in debt funds
With debt fund-focussed mutual funds, the dictum “the longer you invest, the greater the chances of better returns” does not work. Because the money has little scope for capital appreciation. So keep an eye on the interest rate.
There is no one-size-fits-all answer to the minimum time to hold a mutual fund. It depends on the individual and the circumstances. Still, we hope this article has helped you gain some clarity about the holding period that will work for you.
What is the average holding period for a mutual fund?
The average holding period for a mutual fund can vary but is typically around 3 to 5 years.
Factors that could affect your holding period?
Several factors that could affect your holding period for a mutual fund include market conditions, investment goals, financial needs, risk tolerance, and changes in personal circumstances.