If you ask ten investors when they intend to sell, there will be ten different answers. And most likely, they will all be guessing.
For funds comprising growing second-rung companies, there is no need to guess. The key factors here are the company growth dynamics and the degree of drop in price level.
What makes mid-cap funds a long-term investment?
Mid cap funds must invest at least 65% of their assets in companies ranked 101 to 250th in terms of market capitalisation. Such companies are no longer startups, but continue to grow, with potentially better returns along with high price volatility.
In the 2008 crash, the Nifty Midcap 100 index fell sharply and several days were needed for the index to reach its previous level. Those who got out during the crash took the loss, while the rest who stayed invested finally got their gains when the index recovered, years later.
What is the ideal holding period?
Look at a holding period of about 7 years or more. At the very least, 5 years.
To illustrate this, say you invest ₹5 lakh and the fund falls 40% in a bad year, leaving you with ₹3 lakh. To get back to ₹5 lakh, it must now rise by about 67%, not 40%. At 12% a year, that recovery alone takes close to four and a half years.
In one or two years, the funds can underperform the large-cap funds or even give negative returns. But as the years go by, the chances increase.
There is a tax benefit as well. Units held for 12 months or more are subject to long-term capital gains at 12.5% after ₹1.25 lakh exemption every year. The short-term capital gain rate is 20%.
How are these funds different from sectoral funds?
The sectoral funds are funds based on a particular theme, such as banks, pharmaceuticals, IT, etc. If that particular sector is underperforming, then the whole fund will suffer and may take a long time to recover.
Since these funds are spread across several industries, it does not matter if one industry performs poorly. This is the reason why this type of fund suits long-term investment. Sectoral picks require more monitoring, and investors should consider them only as a small portion of their portfolio.
How can you invest for the long term?
Market timing is difficult, so spread your entry. SIP of ₹10,000 per month buys more units in falling markets and fewer in rising markets, thereby reducing the average cost of units. Make it a habit by choosing a fixed day every month.
Increasing the SIP amount by 10% every year as your income increases can greatly add to the final corpus after 7 years.
Keep aside an emergency fund of 6 months of expenses before keeping any money in equity. This will ensure that you are never forced to liquidate in a downturn.
Once a year is enough to review the fund performance. Check its returns against its benchmark and peer group returns. Ignore day-to-day changes in prices.
When should you exit?
Long-term investing does not mean staying invested forever. The reasons to sell are:
- Your goal is in the next two years. Then gradually move the amount to debt funds.
- The fund underperforms the benchmark index, like Nifty Midcap 150, for three consecutive years.
- The category exceeds the allocation you have planned for in your portfolio. Then rebalance your portfolio.
Do not sell just because the market went down by 15%. Instead, start an SIP.
Conclusion
This category demands patience and not timing. Stay invested for 7 years or more, at the very least for 5 years, and use SIP to ride out the volatility.
Exit only if your goal is close, if the fund underperforms its benchmark for several years, or if your allocation is exceeded. Keep your sector investments limited and carefully monitored.