Investing in equity funds for the short term could be fraught with danger of losses. If you are investing in equity funds the normal time horizon should be 5 years or more to register decent gains. However, many investors may think of equity funds for the short term without understanding the implications of such a move.
Here are some of the negative fallouts of investing equity mutual funds for the short term:
Heavy tax may get levied: Equity investments are subject to capital gains. The quantum of tax you will have to pay for your mutual fund investment depends on the tenor of investment in the fund. Long-term capital gains tax (LCGT) and short-term capital gains tax (SCGT) are calculated based on how long you are staying invested.
“In case of equity MFs, if you redeem your investment in less than 12 months, then SCGT is applicable on short-term gains at a flat rate of 15%. If the holding period is greater than one year, then the investment does not attract any LCGT in case of equity MFs including ELSS. So staying invested for a year or more means you can avoid paying that extra 15% on your gains,” said Ajit Narasimhan, Head – Savings and Investment, BankBazaar.com
Exit load can get applicable: Exit load are imposed to encourage investors to remain invested for a longer period and discourage them from withdrawing early. Equity funds, typically, have an exit load that is valid for a year after you invest. ELSS comes with a lock-in period of three years.
Narasimhan further added that if you redeem your units within the period for which exit load is defined, you will have to pay that amount. Exit loads are usually around 1%. It might look like a small amount, but on a redemption of units worth Rs 1 Lakhs, an exit load of 1% will take away Rs.1000. “Investors should remain invested in equity mutual funds for the long term to derive better benefits,” he said.
Financial goals may not get linked: If you have short-term goals like buying a car within a year or so then in such case you must avoid investing your money in equity mutual fund instead keep your money in cash or cash equivalent or in liquid funds.
Many retail investors make this mistake during bull markets when they, buoyed by extraordinary returns, start investing in equity mutual funds for their short-term goals. “Many also invest their short-term surpluses or emergency fund in equity funds, thereby compromising their liquidity. As a result, during subsequent market corrections, they are forced to liquidate their equity fund investments at loss. Instead of being influenced by the emotions of greed and fear, mutual fund investors should follow a proper asset allocation strategy based on their financial goals,” he added.
No gains from compounding effect: You can get good returns on your investment over a short time period but you may not get the benefit of compounding effect if you have not invested your money for a longer term. “Staying invested for a long-term also means better returns because of the power of compounding as well as better rupee cost averaging, which takes away the need to time the market and get good returns over time,” said Narasimhan.
Portfolio may be exposed to risk: One can get good returns on their investment only if they are investing for a tenure of around 5-7 years at least. Failing to do, one may even lose money instead of making gains on their investments. “They should invest in equity mutual funds only when they have sufficient liquidity to meet their short-term goals and emergency fund requirements and for goals that are at least 5 years away,” said Kothari.