What Is Mutual Fund Redemption & How It Works

Mutual funds are the most widely traded investment product worldwide, where a familiar route is offered for easy investment in diversified stocks, bonds, and other securities. An investor decides on mutual funds based on financial goals, risk appetite, and time horizon. However, like any other investment, at some point, an investor may choose to redeem or sell their mutual fund units. 

What is Mutual Fund Redemption?

Mutual fund redemption can be referred to as selling mutual fund units back to the fund house. The transaction here is that one seeks to acquire the units’ current market value from the fund house for the selling process. Redemption is usually carried out on the same platform or intermediary on which you had made your investment, such as through a broker, a mutual fund distributor, or directly from the fund house itself. 

Reasons for Mutual Fund Redemption

1. Financial goals: When an investor reaches the economic goal of investment, say saving for the child’s education or buying a home, he will cash in on mutual funds.
2. Cash need: In some cases, investors need to liquidate money for emergencies or planned expenditures and will liquidate their mutual funds for access to those funds.
3. Portfolio Rebalancing: Redemption may be part of a portfolio rebalancing strategy, where an investor seeks to redistribute his investments in line with changing goals or market conditions.
4. Underperformance of the Fund: Some investors may redeem their units and invest in better-performing funds if the mutual fund is not performing as expected.
5. Tax Planning: Investors may redeem their mutual funds strategically for tax-related reasons, such as to lock in capital gains for tax efficiency.

How to Redeem Mutual Funds?

1. Log in to your investment platform: If you have invested through a mutual fund distributor or an online platform, log in to the respective portal. You can also redeem directly through the fund house’s website or app.
2. Select the fund to redeem: Select the mutual fund from which you want to redeem the units.
3. Decide on the Amount: You can redeem either partially or fully. If you want to redeem partially, specify the number of units or the amount you wish to withdraw.
4. Submit Redemption Request: After selecting the amount, submit your redemption request. If you are redeeming through a broker or distributor, they may assist you in submitting the request.
5. Wait for the redemption process: after processing your redemption request, usually, one to two business days pass before your redemption is fully completed. You will find a credit to your bank account from the payment.

Selling Stocks Vs Selling Mutual Funds: What’s the Difference

While both stocks and mutual funds can be bought and sold by investors, the selling process for mutual funds differs from stocks in the following ways:

Redemption Process:

Stock Selling: You sell your shares directly to another buyer in the open market. Market forces determine the price and are available immediately.

Mutual Fund Selling: You sell your units back to the mutual fund house or asset management company. The price is based on the Net Asset Value (NAV), which is calculated at the end of the trading day.

Methods to Redeem Mutual Funds

There are various ways one can redeem the mutual fund units. Here are the most frequent types:

Complete Redemption: A complete redemption involves full redemption of mutual fund units of your investment in that particular fund. After completing the redemption, your investment in that respective mutual fund remains inactive.

Partial Redemption: Partial redemption lets you redeem only a part of your investment, and the rest of the units remain invested in the fund. This is useful for investors who want to maintain their exposure to the fund but require liquidity.

Switching: Sometimes, an investor might prefer to shift from one mutual fund scheme to another within the same fund house rather than redeem units. It enables continued investment but changes the asset allocation.

Exit Loads Associated With Redemption

An exit load is the fee levied on mutual fund houses when redeeming units before the stipulated period is over; usually, it ranges from 1 to 3 years of investment. This fee is calculated as a percentage of the amount of redemption and acts as a disincentive for short-term trading. The exit load is designed to take care of the costs that the fund incurs due to premature withdrawal from the investments and to ensure that the investors are committed to their investments for a considerable time.

Methods To Exit From Mutual Funds

A Mutual fund investor has several ways in which he can sell his units.

1. Online Platforms: Most mutual fund houses allow direct redemption of the units from the website or other online investment portals. This is the most usual and convenient option.
2. Through Brokers/Distributors: You invest in mutual funds through a broker or distributor. You could contact them, and they shall initiate the redemptions; they will prepare all the relevant documents for this purpose.
3. Direct Redemption via Fund House: You can redeem directly from the mutual fund house, either through its branch or customer service.
4. Mobile Apps: Several fund houses and financial apps provide easy redemption options through mobile applications.

How Do You Avoid Tax on Mutual Fund Redemption?

Although mutual fund investments offer tax advantages, it is essential to understand the tax implications of redeeming units. There are ways to optimize taxes on mutual fund redemption:

1. Holding Period

• Equity Mutual Funds: If you hold your mutual fund units for more than 1 year, the returns are subject to long-term capital gains tax (LTCG) of 10% (on gains exceeding ₹1 lakh).
• Debt Mutual Funds: If held for more than 3 years, debt funds attract long-term capital gains tax of 20% with indexation benefits.
• Switching Instead of Redeeming:
• Sometimes, switching between funds within the same fund house avoids immediate tax implications while keeping the investment intact.
• Tax Harvesting:
• Tax harvesting involves redeeming mutual funds in a way that helps offset taxable gains by realizing capital losses. This can be part of a broader tax strategy.

2. Exemptions on SIP Gains

If you have invested in mutual funds through Systematic Investment Plans (SIPs) and the total holding period for each installment exceeds 1 year, long-term capital gains tax benefits apply to each SIP installment.

When Should You Consider Redeeming Your Fund Units?

When You Have Achieved the Goal for That You Had Invested in Mutual Funds Initially:

• You may have invested in mutual funds with a goal that could have been met at the present time. You may require that benefit.
• When your portfolio is no longer aligned with your risk tolerance or asset allocation, it may be time to redeem some funds and invest in other instruments that better suit new goals.
• In case of a downturn in the markets, investors may redeem their mutual funds to cut losses, though that is often counterproductive. Instead, a more strategic approach would be to stay invested and ride out the volatility.
• If you need funds urgently for emergencies, redeeming mutual funds might be an option to consider.
• If a fund underperforms over an extended period, it may be a good idea to redeem and invest in better-performing schemes.

Conclusion

Mutual fund redemption is a simple procedure, but careful consideration of financial goals, market conditions, and tax implications needs to be given. Whether for liquidity, rebalancing a portfolio, or other reasons, understanding the different methods of redemption and the factors that affect it will help make informed decisions. Evaluating when and how to redeem will allow investors to continue their mutual fund investments in pursuit of long-term financial objectives.

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