What is lock in period in Mutual Funds

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Lock in Period

Meaning of Lock In Period

  • Lock in period refers to the time period for which the investment or the invested amount cannot be sold, redeemed, or withdrawn. 
  • Lock in period of a fund/investment does not mean its investment tenure. The tenure of investment can be more than the lock in period.
  • Lock in period is common in private equity IPOs, hedge funds, some mutual funds, etc.
  • Investors should not wait only until the lock in period to withdraw the funds. They must evaluate the performance of the fund at the end of the lock-in period and decide whether to remain invested or redeem the funds.

What is Lock In Period in Different Types of Investments?

  • Lock-in Period in Mutual Funds: Mutual fund lock in period means that the investor cannot withdraw or redeem the invested amount or the allocated units, fully or partially, during the lock in period. Mutual funds with a lock in period are known as closed funds. Only ELSS mutual funds have a lock in period which is of 3 years.
  • Hedge Funds: Hedge funds come with a lock in period of usually 30-90 days. This gives the hedge fund manager enough time to withdraw the investments gradually without driving the exit against the portfolio.
  • ELSS Mutual Funds: ELSS mutual funds have a lock in period of 3 years. The lock in period in ELSS fund schemes is strict and there is no provision to withdraw the funds by paying a penalty.
  • Tax Saving Fixed Deposits: Tax Saving FDs come with a lock in period of 5 years. The investor is not allowed to withdraw funds before the maturity.
  • Government of India Bonds: 8% GoI bonds have a lock in period of 6 years.
  • ULIP Funds: Unit Linked Insurance Plan or ULIP combines insurance and investment in a single fund scheme. They come with a minimum lock in a period of 5 years.

Importance of Lock In Period

  • Lock in periods works as strict investment plans for investors. Many investors who are new in investing, often withdraw their investments in panic even due to minor market volatility. A lock in period keeps the funds intact for a specific period and gives the opportunity to the investor to earn good returns from long term investments.
  • Investors get to learn the benefits of long term investments from a lock in period. A lock in period allows them to stick to the plan and shows how keeping funds invested for a longer duration turns out to be profitable.
  • Lock in periods also allows investors to reap the taxation benefits of long term capital gains. 
  • Hedge funds managers get sufficient time to exit from the investment. Sudden or too frequent withdrawals from hedge funds disturb the balance of the overall portfolio.
  • In the case of IPOs, the lock in period enables the listed company to use the raised funds and get a strong foothold in the market. It also saves the investor from extreme volatility in the post IPO prices.
  • Lock in periods in mutual funds are necessary as they induce stability in the fund. Excessive selling of funds increases the redemption that creates liquidity issues. A lock in period helps to preserve the liquidity of the mutual fund.

What is Lock In Period in Mutual Funds?

A lock in period in a mutual fund keeps the fund balanced, stable, and liquid. It also gives investors the opportunity to grow the funds and enjoy the benefits of long term investment.

Equity Funds

Equity Linked Savings Scheme or ELSS is the only equity mutual fund that comes with a lock in period. These funds have a lock in period of 3 years. The funds invested in ELSS schemes are eligible for tax exemption of up to Rs 1.5 lakh every year under Section 80C of the Income Tax Act. However, the returns earned from an ELSS scheme are taxable. If the holding period is less than 1 year, the returns are classified as Short Term Capital Gains and are taxed at 15%. Whereas, if the funds are held for more than a year, the returns are called Long Term Capital Gains and are taxed at 10% for gains above Rs 1 lakh.

Debt funds and Hybrid funds do not have a lock in period, i.e; the funds can be withdrawn or redeemed anytime by the investor.

What to do After the Lock in Period?

  • An investor should not withdraw funds immediately at the end of the lock in period. Instead, one should take time to evaluate the performance of the fund and then make a decision whether to redeem the funds or remain invested further. 
  • Although ELSS funds have a lock in period of 3 years, an investor should wait for 5-6 years to check the fund’s performance because investments made in an ELSS fund take time to grow and a period of 3 years is not enough to evaluate its performance.
  • However, in case of a financial emergency where funds are required urgently, the investor can redeem the investments to meet the immediate monetary needs.
  • In case the fund has performed above the expectation in the lock-in period itself, the investor can redeem a partial amount and leave a part invested for more years.

Let us now evaluate some of the ELSS funds performance to evaluate how the funds have performed over the period of 5 years (2 years more than the lock in period)

ELSS Fund5-year Return (Annualised)*
Quant Tax Plan - Direct Plan - Growth27.72%
IDFC Tax Advantage (ELSS) Fund - Direct Plan - Growth21.38%
BOI AXA Tax Advantage Fund - Direct Plan - Growth23.75%
Mahindra Manulife ELSS Kar Bachat Yojana - Direct Plan - Growth15.37%
Baroda ELSS - 96 - Plan B (Direct) - Growth15.97%

* Returns mentioned for educational purposes only not a recommendation.

As clear from the above table, ELSS funds have performed better than many other saving schemes if they are held for a longer period of time. This shows why a lock in period is important for the investors. Investments should be made according to specific goals. As an investor, you should remain vigilant but at the same time, keep patience as well. A lock in period helps you to build that patience and earn higher returns from long term investments.