What is Mutual Fund Redemption and How Does it Work?

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  • 04 Sep 2023

Mutual fund redemption refers to the process of redeeming your mutual fund units. Upon redemption, you get the money credited into your bank account as the applicable net asset value (NAV). Thanks to digitalization, the mutual fund redemption process has become pretty simple. Read on to learn more about it and its working process.

So, why do investors redeem their mutual fund units? There are several reasons for this. Some common ones include:

  • Nearing the Desired Goal

One of the primary reasons for mutual fund redemption is approaching the desired goal. Investors invest in mutual funds for several short and long-term goals. These could be building an emergency fund, accumulating money for a downpayment for a house/car, children’s higher education, etc. Once you are nearing the goal and require money for the same, you can redeem your mutual fund units.

  • Change in the Fund’s Management Strategy

The management style of a mutual fund plays a pivotal role in shaping its investment strategy, risk profile, and overall performance. For investors, a change in the fund's management style can be a crucial signal that prompts careful consideration and evaluation of their investment strategy. In some cases, it may lead to the contemplation of redemption.

Mutual fund managers make critical decisions regarding asset allocation, security selection, and market timing. The management style reflects the approach taken by the fund manager to achieve the fund's objectives. You can redeem if you feel that the fund no longer aligns with the style that prompted you to invest in it.

  • Below Par Performance

When investing in mutual funds, assessing the fund's performance over time is crucial to making informed financial decisions. While the stock market and investment landscape can be unpredictable, consistency and performance are key monitoring indicators. If a fund has underperformed over the years consistently, it's time to consider redeeming your units and exploring alternative investment options.

Consistent underperformance is a red flag that can suggest various issues with the fund's management, strategy, or underlying holdings.

Now that you know the various reasons for redemption, let’s understand the redemption process. The ways through which you can redeem are as follows:

  • Directly Through the AMC

Most Asset Management Companies (AMCs) offer customers a dedicated portal, a mobile application, and a personal relationship manager. If you've acquired mutual fund units through an AMC, you can easily access the portal and initiate the sale of your units. You can decide whether to redeem a portion or all of your units according to your preference. Several AMCs also provide mobile applications that allow you to carry out the same process efficiently.

  • Redemption Through Demat Account

The procedure is quite simple if you bought your mutual fund units using your personal Demat account. You need to log in to your securities account online and submit a redemption request.

Once you've submitted your request, your payment will be processed within a few days through your preferred payment method. Typically, the money will be credited to the bank account linked with your demat account.

1. Unit-based Redemption

In this redemption process, you can indicate the number of mutual fund units you wish to redeem. The amount you receive will be determined by the number of units you redeem and the current NAV of the mutual fund units.

2. Amount-based Redemption

In this redemption process, you can specify the desired amount for redemption. As a result, the system automatically debits the corresponding number of units based on the NAV, ensuring that the requested amount is met.

3. Redeem All

Here, you can redeem their entire investment from the mutual fund.

While the mutual fund redemption process is simple, there are certain things you must remember. These include:

1. Capital Gains Tax

The duration you hold mutual funds impacts your total earnings. Equity funds classify a period of less than 12 months as short-term. If you redeem within 12 months, it's termed as short-term capital gains and attracts a tax of around 15%. Long-term capital gains (holding for more than 12 months) within Rs 1 lakh are tax-free, while those above this limit incur a 10% tax.

In debt funds, the tax system differs. Short-term capital gains (units sold before three years) are taxed based on the investor's applicable tax rate. Long-term capital gains are taxed at 20%, considering indexation.

Typically, short-term gains face higher taxes compared to long-term gains. Therefore, when applying for redemption, it's crucial to factor in the taxation amount for a comprehensive understanding of your overall profits.

2. Exit Load and Other Charges

If you redeem mutual funds before their maturity face charges in the form of exit loads, which vary based on the type of mutual fund investments. These charges are a fixed percentage, typically ranging from 1% to 2%.

The Ministry of Finance imposes a securities transaction tax (STT) of 0.001% in specific fund cases. This tax is applicable when investors opt to buy or sell units of equity or equity-oriented funds. However, this tax does not apply to debt funds.

These charges can impact the overall investment returns. Therefore, it's crucial to carefully consider these charges before initiating the redemption process.

3. Day and Time

Mutual funds determine their settlement according to their NAV, which signifies the value at which the fund is exchanged on the market. The exchange operates with a current cut-off time for this NAV, which is set at 3 p.m.

Submitting your application before 3 p.m. results in the redemption of mutual fund units at the NAV of the current day. However, if your application is processed after 3 p.m., the redemption of mutual fund units will occur using the NAV of the following day. This situation can significantly impact your ultimate earnings, particularly if a noticeable difference exists between these two NAVs.

To Sum Up

Redeeming a mutual fund is a deeply personal decision that hinges on an individual's unique goals, prevailing investment opportunities, financial responsibilities, and unforeseen circumstances. Investors must meticulously contemplate prevailing market conditions, potential tax ramifications, and the overall financial landscape before proceeding with the redemption process.

FAQs on Mutual Fund Redemption Time

From 1 February 2023, all Asset Management Companies (AMCs) will implement a T+2 redemption payment cycle for equity mutual fund schemes.

You can redeem your investment in an open-end scheme at any time. The only exception is an investment in an Equity Linked Savings Scheme (ELSS), which has a lock-in period of 3 years. Apart from ELSS, there are no limitations on redeeming investments.

In accordance with Section 194K, a mutual fund isn't required to make deductions for TDS (Tax Deducted at Source) on capital gains resulting from the redemption made by the holder. However, the current income tax regulations do impose taxation on the dividends paid by the fund houses or Asset Management Companies (AMCs) on behalf of the investor.

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