What is Lock in Period in Mutual Funds & Why is it Important?
It’s no secret that long-term investments in mutual funds are important for your financial welfare, providing a platform for wealth accumulation and growth. In this digital age, where immediate accumulation of funds is supreme, as investors we may have encountered the concept of a mutual fund lock in period. The lock-in period is a predetermined duration during which investors are restricted from redeeming or selling their mutual fund units. Now, let’s explore the significance of lock in period of mutual funds by understanding about different investment avenues. Let’s begin.
What is Lock in Period of Mutual Funds?
We will understand the lock in period in mutual funds meaning with the help of a general example. I’m sure most of you have added ‘joining a gym’ to your list of resolutions. Great!
Now imagine committing to a gym membership for a year. The upfront decision to stay locked in for that period encourages regular attendance and a consistent fitness routine. Similarly, a mutual fund lock-in period works as a commitment, urging investors to stay invested for a specified time, fostering financial discipline and aligning their goals with the fund’s objectives.
A lock in period in mutual funds is the time period in which investors cannot sell, withdraw or redeem their mutual fund units. Simply put, investors are obligated to remain invested for a specific time period and it’s advisable not to withdraw money right away once the mutual fund lock in period ends.
Lock in period in mutual funds isn’t uncommon. All closed ended mutual funds have a lock-in period while open ended mutual funds may not. However, there is an exception to this norm, as Equity Linked Savings Scheme (ELSS) funds impose a mutual fund lock in period 3 years. During this time frame, investors are restricted from selling their investments. Once this stipulated period concludes, investors gain the flexibility to either remain invested in the fund for as long as it exists or opt to sell their mutual fund units.
Why is Mutual Fund Lock in Period Important?
Some of the reasons why lock-in period is important are given below:
- Encourages investors to stay committed to their investments, fostering the potential for long-term financial growth.
- Lock in periods are a crucial feature of mutual funds that may help to maintain liquidity and ensure stability within the fund structure.
- When seeking to deduct income taxes from assets, it can provides a strategic advantage for investors.
- In the case of hedge funds, the lock-up period allows fund managers the necessary time to manage less liquid assets or gradually adjust their investment portfolios.
The lock-in phase is particularly significant for startups and firms going public through an IPO. The instant sale of stock during the post-IPO lock-up period is prohibited as it could be affected by volatility and artificially inflated share values.
Different Mutual Fund Lock in Periods
Let’s have a look at the different types of mutual funds with distinguished lock in periods.
Equity Mutual Funds
Within the category of equity mutual funds, the Equity Linked Savings Scheme (ELSS) stands as the sole fund type featuring a lock-in period. ELSS mutual fund lock in period 3 years. Investments in ELSS funds qualify for the tax exemption under Section 80C of the Income Tax Act, up to a limit of Rs.1,50,000 per annum. However, the ELSS investments are taxable. Thus, the Short Term Capital Gains Tax (STCG) of 15% is applicable if the holding period is less than one year, while Long Term Capital Gains Tax (LTCG) of 10% is levied on capital gains exceeding Rs. 1,00,000 for holdings surpassing one year.
Debt Funds
Debt Funds consists of a total 16 fund types within the category. However, these types of mutual fund without lock in period.
Hybrid Funds
Similar to other types of funds, these mutual funds without lock in period are present.
How to Check the Lock-in Period of a Mutual Fund?
The lock-in period varies from fund to fund and depends on the type of mutual fund.
Now let’s have a look at steps that you can follow:
- Visit the mutual fund’s official website or access the Securities and Exchange Board of India (SEBI) website.
- Look for the mutual fund scheme you are interested in and proceed to the scheme details page.
- Examine the section dedicated to the lock-in period. You can also find Information about the lock-in duration can typically be found in the scheme information document (SID) or the mutual fund scheme’s key information memorandum (KIM).
- In some cases, where you might not be able to find the information on the website, it is advisable to contact the mutual fund company’s customer support or visit the nearest branch.
- It is important to verify the lock-in period before making an investment in a mutual fund, as this factor can significantly impact your liquidity and overall investment objectives.
Lock in Period of Other Tax Saving Investment Schemes
ELSS funds are tax saver funds. Apart from the ELSS, let’s have a look at the other tax saving schemes below
| Scheme Name | Lock In Period |
| Tax Saving FD | Mutual fund with 5 years lock in period |
| PPF | Mutual fund with 15 years lock in period |
| NPS | Till Retirement |
| NSC | Mutual fund with 5 years lock in period |
What Should I Do After the Lock-in Period Expires?
Once the mutual funds lock in period ends, investors should straight away redeem their mutual fund investments. However, you should ideally assess and evaluate the performance of your scheme. Thus, let’s take an example of ELSS funds for better understanding.
Evaluate the Performance of the Scheme
ELSS funds offer more than just tax savings. They also aim for long-term capital appreciation. While many investors use ELSS funds primarily for tax-saving purposes, redeeming the investment after the three-year lock-in period to invest in a new ELSS fund can limit the benefits. ELSS funds invest in equities and operate as diversified multi-cap funds managed by experienced fund managers who charge a fee for their services. It is advisable for investors to stay invested in these funds for at least 5-7 years to maximize the benefits. A 3-year period may not be sufficient for equities to reach their full potential, but it’s recommended to conduct a fund review after this initial period.
Decide to Stay Invested or Not
After 3 years, you can evaluate the ELSS funds and decide whether it aligns with the current investment objective or not. If the fund is growing, it is aligned with your financial goals. Then you may stay invested in the scheme for a longer haul. However, if the fund’s performance isn’t satisfactory, then it would be better to redeem your investments.
Redeem the Investment
Investors must not keep base mutual fund lock in period as the investment tenure. It’s there to protect you and keep the fund stable. ELSS funds have a lock-in period of three years. Therefore, it is advisable to only redeem your investments before the lock in period in terms of emergencies like medical emergencies or uncertainties.
What to Avoid Once Your Mutual Fund Lock-in Period Expires?
If your mutual fund has a lock-in period, like an equity-linked savings scheme (ELSS), and it’s over, it’s better not to withdraw the money right away. Some investors cash out immediately after a 3-year lock-in period. Others reinvest the money in a new ELSS just for tax benefits. However, this can be a mistake as the new investment may not lead to good growth and could hinder your other financial goals. However, it’s important to do your own research and/or consult a financial advisor before investing.
To Wrap It Up…
Mutual funds with lock in period not only impose restrictions on selling investments. In certain aspects, a lock-in period may serve as a safety net, primarily seen in hedge funds, IPOs, and specific mutual funds. For new investors, the mandatory waiting period can be advantageous, imparting valuable lessons about the principles of long-term investing. As always, investors must do their own research and/or consult their financial advisor before investing.
FAQs
The minimum lock in period for mutual funds varies from fund to fund. Close funds are mutual funds with lock in period. However, the minimum lock in period for ELSS funds is 3 years.
It is okay to break a mutual fund investment if it is open ended since they do not have a lock in period. However, when there is a mutual fund lock in period 3 years like in ELSS funds. It is advisable to break investments to enjoy the return and its further growth.
No, you cannot sell, withdraw or redeem during the lock in period. This may result in penalties or loss of tax benefits.
If a mutual fund consistently underperforms for an extended period, typically 1-2 years, it is generally recommended to sell it. However, investors should reflect on the reasons for the below-average performance and evaluate the probability of similar issues arising again in the future.
