Investing in mutual funds is a very lucrative option.
It is very difficult to understand this financial tool because of the terms and subjects that are attached to it.
Thus, this blog is specially written to understand what the lock-in period in mutual funds is and also the elements attached to it.
What are mutual funds?
A mutual fund is a financial vehicle that is used to invest in securities such as the following:
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Here, a pool of money is generated through several investors, which will then be professionally managed and invested in various funds.
Some of the mutual funds contain a lock-in period, while some may not have the same.
There are two modes of investing in mutual funds and they are as follows:
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In the SIP, or Systematic Investment Plan, you will contribute a fixed amount on a regular basis.
Whereas, in the lump sum method, you will have to make a one-time investment.
Generally, all the mutual fund schemes have got the lock-in period option, which will enable you to enjoy the tax-benefits.
What is a lock-in period in mutual funds?
There are three types of mutual funds, as follows:
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Of the above, close-ended mutual funds have a minimum lock-in period that ranges from 3–5 years.
There is also a restriction on the entry as well as exit periods of the fund where the price per unit is always lower than the normal price scale.
The lock-in period is considered to save investors from the urge to redeem returns on a short-term basis, thus enabling them to have potentially high returns.
In short, the lock-in period refers to the period during which the investors are prohibited from redeeming the units of the fund, either partially or wholly.
In India, many mutual funds do not have a lock-in period.
The latest update on the lock-in period:
According to the most recent update from November 2018, the Securities and Exchange Board of India (SEBI) intends to impose a short-term lock-in period for investments in liquid mutual funds with an asset base of more than Rs. 8 lakh crores.
The basic opinion of the expert fund managers is that the lock-in period of the liquid funds should be enough to smooth the volatility, whereas the longer lock-in period might kill the very essence, as well as the attractiveness, of the liquid funds.
The importance of the lock-in period:
The lock-in period of the mutual funds is required to restrict the investor from making any sort of modification to the investment.
It might happen that the frequent changes might affect the equilibrium of the fund and lead you to en-cash the returns in a very short time.
Fund houses tend to impose the lock-in period so as to curb your need to liquidate the funds.
The best advantage of the lock-in period is the income tax benefits that you can claim.
What to do after the lock-in period expires?
Once the lock-in period ends, you can avail of the following:
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Review the performance of the fund:
After the lock-in period of three years is over, you should review the performance of the fund.
Many investors might end up transferring the money to start with ELSS.
However, if your objective is just tax-saving, then you will not be able to reap the best benefits of the ELSS fully.
Once the scheme expires, you should keep the money invested for a period of at least 5-7 years.
The main reason behind this is that equity funds will deliver good returns if they are kept invested for a long time.
To review the performance of the fund, you will also have to assess the historical risk-adjusted returns over the past 5–10 years and then compare them with other funds in the same category.
Treat the investment as another open-ended scheme:
You can also continue the investment as an open-ended scheme or transfer the money to some other equity-based scheme that is suitable to your objectives.
If you wish to stay in for a longer period, you may observe that the returns generated by these funds have outdone the amount that is saved in taxes.
In many cases, it has been observed that the ELSS has outperformed large-cap funds.
Being a multi-cap fund, the ELSS tends to provide a cushion against volatility.
En-cash the fund:
You cannot simply exit a mutual fund because the lock-in period is over.
After the completion of 3 years, the ELSS becomes an open-ended fund, wherein the investor can redeem the units as a whole or in a lump sum.
Here, there is no exit load or tax levied upon such as an exit.
We hope that the above blog gives you clarity about the lock-in period in mutual funds.
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Frequently Asked Questions (FAQs):
Q#1) What is a lock-in period?
Answer: Lock-in period is nothing but a tenure during which investors are prohibited from selling their units of mutual funds.
Q#2) Do all the mutual funds have a lock-in period?
Answer: Most of the mutual funds in India do not have a lock-in period. It is only an ELSS, or tax-saving scheme mutual fund, that has a lock-in period of 3 years.
Q#3) Do I need to invest in a lump sum for an ELSS fund?
Answer: Yes, you can invest in a lump sum or through SIPs with an amount that is as low as Rs. 500.
Q#4) What is the tax-rebate that is available on ELSS during the lock-in period?
Answer: You can directly avail a tax deduction of RS. 150,000 under section 80C once you invest in an ELSS fund.