What is the lock-in period in mutual funds?
There is a host of investment opportunities today for those looking for wealth creation via investing savings. With the growth of the fintech sector, the choice of these options has further expanded a great deal. Some of the traditional investment means - like a savings account and term deposits have been replaced to a large extent by newer options, such as mutual funds, ULIPS, and more.
One of the most important reasons for the massive inclination towards mutual funds is that they are suitable for many different types of income groups. Individuals naturally have varying levels of comfort and capacity when it comes to channeling their money in to a mutual fund. The historical reliability of generally good returns has also made mutual funds a widely preferred choice of investment. Additionally, companies offering attractive mutual fund schemes have successfully driven customers towards this type of investment.
Because of this popular preference for mutual funds, there are several types of schemes available in the market today. An Equity Linked Savings Scheme (ELSS) is one of the top mutual funds schemes and an extensively invested option due to the tax exemption it offers as per Section 80C of the Income Tax Act. Such schemes involve a fund manager who channels the invested money into different equity instruments to ensure high returns. But an ELSS is a close-ended scheme that comes with a statutory lock-in period.
This lock-in period is a characteristic feature of many mutual fund investments. This post elaborates on the details about a lock-in period and how to go about it.
Check out some of the top mutual funds to invest in 2018.
What is a Mutual Fund lock-in period?
- Several mutual fund investment schemes come with a period until which the investor is not allowed to withdraw or sell the fund units. This span of time is termed the lock-in period. The average lock-in period for ELSS mutual funds is 3 years.
- If the investor decides to redeem their units before the maturity of the lock-in period, then they don’t receive the full benefits from the investment. Furthermore, if the funds are withdrawn within a year of investment, then the investor may also have to pay 1% exit load in addition to the other charges.
- This lock-in period is not applicable to open-ended schemes such as Growth Plan, Dividend Plan, and others.
How does the lock-in period work?
There are different conditions for the working of the lock-in period in different kinds of schemes.
- For instance, say you have invested Rs 10,000 in ELSS or any other tax saving mutual funds, on 1 January 2018. You have bought 100 units for Rs 100 per unit. Under the lock-in periods, these 100 units are not available for withdrawal until 1 January 2021.
- In another instance, you have invested Rs 10,000 in SIPs with 5 different instalments, first on 1 January 2018. The lock-in period will vary for the units bought under different instalments and you can redeem your first set of units on 1 January 2021. Every instalment is considered a separate investment.
What is the significance of a lock-in period?
- A mutual fund scheme may have a mandatory lock-in period to ensure that its investors don’t make frequent changes to the funds at hand. Repeated alterations can negatively impact the roadmap or plan a fund may be working towards.
- Another factor that signifies the need for a lock-in period is Income Tax laws. As per these laws, an investor can claim tax deductions on the income received in the form of returns from mutual funds (Equity Linked Savings Schemes) with an established lock-in duration.
- The simplest reason for the presence of a lock-in period is to ensure that the money is invested in the market for a time long enough to create profitable returns.
Open-Ended vs Closed-Ended Mutual Funds
- There are two kinds of mutual funds based on lock-in period. The schemes that do not have any lock-in duration are categorized as open-ended. An open-ended mutual fund works as a low-cost investment vehicle. There is no fixed maturity period for these schemes. On top of this, there are less restrictions when it comes to purchasing and withdrawing stocks.
- Both open and closed-ended schemes involve a fund manager distributing the stocks among different hand-picked instruments. Open-ended funds, however, have unlimited shares in comparison to the fixed number of shares in closed-ended schemes.
- Open-ended schemes have an advantage over closed-ended schemes when it comes to liquidity due to the absence of a lock-in duration. Furthermore, selling open-ended funds from a portfolio also provides the investors with the underlying assets’ intrinsic value price.
Mutual funds are considered as one of the most viable investment options of all. You should of course, consider the duration of lock-in period before investing your money in any scheme. While the presence of a lock-in period makes the investment a little inflexible, some may agree that this fixed period ensures higher returns for the investor.