Mutual funds provide high returns and are one of the most accessible investing solutions for people of all income levels. They pool money from numerous investors and invest in various asset classes.
However, mutual funds contain a few terms that require clarification. The lock-in period is one such term explained below to make things easier for you.
What is Lock in Period in Mutual Funds?
A mutual fund’s lock-in period maintains the fund’s stability, liquidity, and balance. Additionally, it offers investors the chance to increase their capital and enjoy long-term investment benefits.
The only equity mutual fund with a lock-in period is Equity Linked Savings Scheme (ELSS). Most mutual funds in India don’t have a lock-in period.
ELSS is the one exception from the category of open-ended schemes. They are mutual funds that save taxes and have a 3-year lock-in period.
It applies to both lump-sum payments and SIPs. Section 80C allows you a tax deduction of up to Rs. 1,50,000 on these funds.
Debt Mutual Funds include 16 different types of funds. There is no lock-in period for any of these funds.
Unlike other kinds of mutual funds, hybrid funds do not have a lock-in period.
What is Lock in Period in Different Types of Mutual Funds?
The lock-in period for various investment categories is as follows:
Hedge funds often have a lock-in period of 30 to 90 days. This allows the hedge fund manager to gradually withdraw the investments without affecting the portfolio.
ELSS Mutual Funds:
ELSS mutual funds have a 3 year lock-in period. There is no provision for a penalty-free withdrawal of the funds during the strict lock-in period.
Tax-Saving Fixed Deposits:
Tax Saving FDs have a 5-year lock-in period. Before maturity, the investor is not permitted to withdraw money.
Government of India Bonds:
The lock-in period for 8% GoI bonds is 6 years.
Unit Linked Insurance Plan (ULIP) Funds:
The ULIP combines investment and insurance into one fund structure. They have a 5-year minimum lock term as standard.
Why is Lock-In Period Important?
- The investor cannot sell the units accumulated during the lock-in period.
- This is done to maintain the same number of units and total fund size.
- Too much change in the fund’s size or withdrawal of units can disturb the fund’s stability.
- The Government of India has specified that funds invested in ELSS are tax deductible under 80.
- This motivates investors to engage in equity markets and stays invested long-term in gaining more profits.
- More market investment promotes capital formation, which benefits the country.
- Generally, mutual fund houses fix a specified lock-in period to retain customers for as long as possible and prevent sales and redemptions from occurring too often.
- As a result, the investors will gain more from equity investments and will be required to keep their assets long-term.
What to do After the Lock In Period Ends?
Investors are not permitted to redeem their units during the lock-in period. Before deciding whether to redeem or not, a thorough review is essential.
Examine the Performance of the Fund or Investment:
You must evaluate your investments once the three-year timeframe is over. For example, ELSS funds provide both long-term capital gains and tax advantages.
But most investors make the error of considering it only as a tax-saving strategy. As a result, they move the funds to invest in another ELSS fund.
These multi-cap funds invest in equity that does not increase to its maximum potential within three years. You must remain invested in the fund for a minimum of 5 to 7 years to achieve the highest possible returns.
Decide Whether to Stay Invested or Not:
When the mutual fund lock-in term expires, you can continue your investment as an open-ended fund. You can also transfer the funds to any other plan that matches your financial goals.
However, you must only stay if the fund’s performance suits your investment goals. It is preferable to redeem your investments and make new ones if your objectives and the performance review do not match.
Redemption of Investment Units:
The lock-in period cannot be considered your investment term, and you cannot withdraw from the fund once it has ended. Redeeming the funds is only a good decision when necessary, such as in an emergency medical situation.
As the fund becomes open-ended, the units can be redeemed in whole or lump sum.
As a result, rather than completely withdrawing your investment, you can redeem only a portion of it. To summarize, the lock-in period prevents you from selling your investment to gain long-term investment rewards.
What Are the Benefits of Lock-in Period in Mutual Funds?
The lock-in period is beneficial for both investors and the funds. Some of the advantages are as follows:
- It enables investors to retain their investments for longer to receive long-term investment rewards.
- Many investors withdraw their funds for fear of minor market fluctuations. The mutual fund’s lock-in period prevents this and keeps the fund intact and stable.
- It focuses on establishing stability in the funds.
- When it comes to ELSS, it enables you to deduct income taxes from your taxable income. The maximum tax deduction allowed by Section 80C of the Income Tax Act is Rs. 1,50,000.
- Investors can gain knowledge about market changes by staying with their assets for a long time.
- It is important if you are investing to reach your financial objectives.
During a lockup period, you cannot sell your investments. It also gives investors the possibility of raising more capital. A lock-in time does not define the duration of an investment.
It is just a restriction by the AMC or organization to safeguard market liquidity and stability. Investors are not compelled to redeem their holdings in ELSS funds after the lock-in period has expired. However, monitoring an investment is crucial once the lock-in period has passed.
Investors are only permitted to sell their holdings in a fund if it isn’t performing as planned or when they need money for an urgent need. The redemption of current assets is not advised for investors who want to invest in a new ELSS fund after the lock-in to reduce their tax burden.