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How to safely exit long-term equity mutual fund holdings

What’s the right way to protect the gains that you may have already made in equity funds? It’s time you explored the Systematic Withdrawal Plan (SWP) option.

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Last Updated: May 19, 2020, 06.05 PM IST
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You must exit long-term holdings of mutual funds securely.
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By Dhirendra Kumar

How can you ensure that if you have been saving and growing your wealth over the years, then an event like the Covid pandemic does not slash and burn through your portfolio within months? Even though Covid-19 is a new phenomena, there’s nothing new about the problem I’m talking about. Whether it was the dotcom crash or the 2008 financial collapse, there have always been events that have threatened to trash your investments just when you were about to need the money. This time is no different.

Amongst investors in equity mutual funds, the talk of the last three months has been how much value their investment portfolios have lost. At the end of March, the crash in values looked apocalyptic, with funds having lost up to 40%of their peak value before the crash. April brought some relief as, against all expectations, just as the Covid was becoming a globe-girdling pandemic, equity values staged a recovery. However, regardless of what actually happens, one sees laments on twitter about how the value of money accumulated for this or that purpose has been decimated by the crash in equity funds.

At Value Research, this problem of a safe exit from a long accumulated portfolio has always been in focus. This is something that we always discussed in our books and magazines, as well as in the columns that I write. The standard advice that we have always given is that just as one must enter equities gently through SIPs, one must exit through SWPs. For planned exits, where one knows beforehand roughly when one needs the money, the thing to do is to start withdrawing the money through an Systematic Withdrawal Plan some time before the target date arrives.

For those who are not familiar with the concept, SWPs are a regular redemption from a fund. There are a number of variations. Investors can either redeem a fixed amount, a fixed number of units or all returns above a certain base level. Often, they are a convenient way to make a regular income from a fund investment. However, they function very well as a way of safely withdrawing from long-running investments too.

The idea is simple but easy. Let’s say that you had accumulated Rs 20 lakh in a set of equity funds that you needed about now. Let’s say the money was in funds that together had the same performance as the Sensex. The value of the money would have dropped from Rs 20 lakh in late February to Rs 15 lakh now. Not good.

The SWP technique that we suggest would mean that around February 2019, you should have started a monthly SWP of roughly 1/12th of the value. If you had Rs 20 lakh in equity funds in February 2019 and you started withdrawing them at this rate, then you would have been able to get out about Rs 19.8 lakh over the year. There would have been some opportunity loss too but ignoring that is exactly what this is all about. This technique always works in sharply reducing any potential losses that you might face.

The question then arises as to how we know whether one year is the right period. This started as a rule of thumb, but recently, when there has been an intense interest in this technique, we have done a little research project comparing one, two and three-year periods over a long period of time and one year turned out to be the best. Here’s what we did: We took the Sensex’s entire history and assumed that there was a fund that gave exactly those returns. There wasn’t, but that does not matter for the purpose of this experiment. We ran a set of simulations (1110 odd in all) of making 10 year investments and then withdrawing them through an SWP of one, two or three-year period. The one-year period was the best in terms of delivering the best returns (which is obvious) but also overall the least variability as well as the least worst minimum returns.

In short, there will always be sudden crises, now and in the future. For long term accumulations that are needed at a known point in time, a one year lead time is enough to make a neat exit.

(The author is CEO, Value Research)

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(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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