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For those of you who saw portfolio returns soar in 2007 only to crash in 2008, it meant losing a chance to convert paper profits to cash. But did you know that mutual funds offer you a viable solution to avoid these kinds of misadventures?
Popularly called the trigger option, mutual funds allow you to set a pre-determined level at which your money will be automatically redeemed or switched from your equity fund to cash or debt fund options.
How triggers work
Trigger options can be chosen either when you start your investment or at a later date. The occurrence of an event, determined by you, will set the trigger to shift your money.
The trigger could arise from events such as the net asset value (NAV) reaching a certain level fixed by you or based on the movement of key index such as Sensex or based on investment returns. For example, if you bought a fund at say an NAV of Rs 12, at the time of investing, you can give a mandate to the fund to book the profit or shift the capital to a debt fund when the NAV reaches say Rs 18. You also have the option of allowing the fund to sweep some money, when say, the Sensex hits 19,000 at the end of a trading day. There are also triggers for switching on a particular date that you decide.
You can customise the triggers, within the broad options given by the fund house. In fact, triggers are not just to curb upside gains; there are options provided by some fund houses to redeem if the NAV/index goes below a certain level.
In most cases, the money is moved to a short-term or liquid fund from where you can always withdraw or redeploy later.
Fund houses such as Birla Sun Life, IDFC, Reliance, UTI, Tata and Quantum, to name a few, allow you to use this option. In fact, a few such as Tata Mutual also have a dividend trigger option that allows you to set a trigger to take money out in the form of dividends. This is a superior option for tax purposes. A trigger to switch or redeem will be equal to selling units of the fund and attract capital gains if units are sold within a year. But removing profits using dividend option will not entail any tax outgo at your end.
When to use
Trigger options are useful for investors with a short to medium-term perspective. If you have a goal in say 2-5 years, it is possible that a sharp market fall just before you reach your goal may snatch the returns you made that far. For instance, let us assume you invested money in 2007, with a five-year goal. In 2007, diversified equity funds managed an average 60 per cent return in the rally. Had you held on to one of these funds, their average return five years hence (i.e. now in June 2012) will be 5.5 per cent a year or only 30 per cent, in absolute terms. By not booking the profits then, you would have lost almost half the profits now. Even if you have a long-term perspective of 10 or 15 years, triggers are useful tools if you are constantly apprehensive about market movements. They provide you the luxury of not having to constantly track the markets. In fact, triggers come in quite handy if you hold theme/sector funds which are typically prone to massive rallies or sometimes, acute underperformance.
Limitations
Triggers have to be set and used judiciously. For instance, setting a trigger of booking profits after your NAV doubles may not be a great idea as it is not often that you make such returns in the medium term. A periodic profit booking after a 20-25 per cent return or when markets deliver 12-15 per cent may be a better idea.
Conversely, setting a very limited target may also mean losing out on any prolonged rally after you achieve the trigger.
You must also be careful about choosing the debt fund in to which the profit booked will be parked. A short-term or liquid fund will curtail any interest rate risk.
Once a trigger is achieved, it will cease to exist. But you can set multiple triggers or set a new one again. A few fund houses such as HDFC and IDFC offer ‘invest' triggers to invest into funds when the markets reach certain levels. But then, if you have a fixed financial goal in mind, then regular and systematic investment may be a better way to build wealth.
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