Even as Chennai and other towns in Tamil Nadu are slowly inching back to normalcy after the devastating floods, the aftermath poses a big challenge to those who survived it: spend again to repossess all that was lost in the flood – especially consumer discretionary items like a refrigerator, washing machine, and so on. I reckon only a handful would have actually got themselves insured against such a calamity. Looking back now, we realise why that would have been the most sensible thing to do.
While some may be lucky to receive interest-free loans from their corporate employers to help them buy white goods, the rest have to either dig in to their savings, or go for EMIs. Now that leads us to the question that some of you often ask us – “If you need some money suddenly, should you liquidate your mutual funds?”
The easiest answer to this would be: use your emergency funds. That is, of course, provided you had one. Situations such as the present one amply show why an emergency fund is important. Calamities like this can strike anywhere, anytime. If you do not have an emergency fund, consider building one in liquid/ultra short-term mutual funds from today. It is never too late, and it will remind you why cash is king not only during such a distress situation, but also when sudden cash outflows happen due to unplanned expenditures.
Here’s another question: What if you did not have an emergency fund, and have a stream of expenses lined up, like it is now for many folks in Chennai? You have three options: one, to break your savings/investments; two, to go for a loan / buy products through the EMI options tagged with them; or, three, opt for a combination of both. Despite the interest rate decline, personal loan rates remain high. It may be better to avoid or keep such loans to the minimum, if you can. Remember, they burn a hole, and do not also fetch you any tax rebates.
Go for EMIs only if you think you can bear it without hurting your other regular monthly commitments, including your SIPs. It is not a good idea at all to stop your SIPs to start your EMIs. Remember, as the advertisement goes, SIPs are good EMIs!
So, if a situation does come where you have to break your investments, what would you do?
Show the door to deposits first: Without much ado, I would say break your deposits first. I am not saying this because it is not a mutual fund product. The simple return numbers will tell you it is more expensive to service a personal loan, and you would have net cash outflows when comparing it with what a deposit will fetch. That means you are better off breaking your deposit to fund your expense, rather than taking a loan that will leave you with a net cash outflow. Most deposits only leave you with a lower interest when broken earlier than maturity. Even in the event of suffering a penalty, it may still make sense to resort to it when you are cash strapped.
PPF withdrawal: If you have not specifically earmarked your Public Provident Fund (PPF) for any goal within the next 2-3 years, and if your PPF has run for a good while (at least 7 years), you may wish to consider partial withdrawal. Remember, you can withdraw only to the extent of 50 per cent of the balance you had at the end of the 4th year. But if you are the kind who regularly invested a chunk of your tax-saving investments here, then chances are you would have a neat sum.
Why did we mention this as an option next only to fixed deposits? Because, PPF actually delivers better returns than regular FDs, given the tax exemption on the capital and interest. FDs are less tax efficient, as the entire interest is taxable, thus yielding you mediocre returns anyway.
Remember, both the above options assume that you do not have the need for the money for any key goals coming up in the next couple of years.
A few stocks can fund you: If you are a direct equity investor in the stock market, sell a few stocks that delivered well. These stocks must have either run up on valuation since you bought, or you could actually be booking losses on those that hold no prospects; it does not matter. You need the cash and you are better off existing those with lowered prospects – the ones that delivered, and those that did not. You can also use the opportunity to reduce your holding on overweight sectors – for instance, reduce the number of banking stocks if they account for a chunk, and so on.
If you have to use mutual funds: Mutual funds are the easiest to liquidate. But do remember, it is probably the best returning investment product you hold. That’s why you need to resist the temptation of digging into them first. However, when you have no choice, here are some points to keep in mind when you redeem a part of your mutual fund portfolio:
- As a broad rule, if you are saving with goals in mind, keep the kitty for near-term goals untouched, and dip in from the very long-term goal portfolios of say 10 years, or more. You can always make it up, provided you run your SIPs, and also up them regularly.
Liquid funds, ultra short-term funds, and short-term debt funds – in that order would be the category for you to first redeem, if you have to.
While it may be tempting to exit your long-term debt funds as they deliver lower than equities, as an asset class, please remember that debt funds are necessary to provide you the diversification, especially in volatile markets. Hence, do not make a clean sweep there. Take a proportion from long-term debt and the rest from equity, so as to roughly maintain your original asset allocation.
When it comes to exiting equity funds, most investors look at two factors: exit load, and taxation. It is fine to look at these; however, do remember, neither of these matter when you are sitting with poor quality equity funds. Remember, this could be a good time to clean your portfolio. Hence, start with those funds that you know are wealth draggers, or check with your advisor on which ones to exit based on performance.
Once the poor performers are removed, you might want to look at equity categories. High risk sector funds on which you have adequate profits are also ripe candidates. Do not mull over their future potential if they have delivered you higher double-digit annual returns in the past 2-3 years, when compared with regular diversified funds.
Similarly, mid-cap funds would have likely delivered higher (in a long-term portfolio) than other fund categories. But that means the proportion of mid-cap funds in your portfolio would be inflated. Use this opportunity to book some profits from some of the funds (when we say book profits, we do not mean sell the entire holding. Sell only a part of your holding first before going to the others.
If none of these are applicable, and you have only good diversified/large-cap funds, remove proportionate units to see if you will not suffer any load or tax (this requires a holding of over one year).
While the ideal scenario would be not to disturb your equity fund portfolio, you may end up exiting them for want of cash in emergencies. Still, the damage would be less if you ensure your SIPs are kept running, instead of substituting them with EMIs. Remember, you are then substituting delayed gratification with delayed pain. Choose wisely.
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