What is Lock-In Period in Mutual Funds & Next Steps?

6 mins read
by Angel One
Lock-in periods are an extremely important piece of detail that should be considered before making any investment. Read on to know more on how lock-in periods affect your investment outcome.

What is a lock-in period?

During the lock-in period, the investment or the amount invested cannot be withdrawn or sold. Common applications of the period include ULIPs, mutual funds, etc. Insurance contracts provide a lock-in term that enables investors to maintain liquidity. The term “lock-in time” describes the length of years during which investors are unable to sell or withdraw the money they have invested. The investor should not remove the money right away when the lock-in period is finished; instead, they should monitor the money’s performance. The number of investment years and a lock-in period are two distinct concepts. The lock-in period encourages the investor to hold onto their investment and gain in the long run. A lock-in time is beneficial when the investments are goal-based investments.

What is lock-in period in different types of investments?

Now, let’s take a closer look at the lock-in periods associated with various investment options:

  • Mutual Funds

There are two major types of mutual funds depending on their lock-in periods. Closed-ended mutual funds have a fixed term, usually 3 years, during which investors cannot redeem their units. However, Equity Linked Savings Schemes (ELSS) are open-ended funds that have a relatively short lock-in period around 3 years. 

  • Tax-Saving Fixed Deposits

These deposits have a five-year lock-in period in order to encourage long-term commitment among the investors. Withdrawing before the end of the lock-in term usually results in penalties thereby encouraging disciplined saving culture among investors.

  • Government Bonds

Government bonds provide secure investment options with different lengths for their respective lock-in periods. For example, National Savings Certificate (NSC) has a five-year lock-in period while Public Provident Fund (PPF) provides for 15 years.

  • ULIP Funds

Unit Linked Insurance Plan’s (ULIPs) offer pool investment as well as insurance opportunity. Such plans generally come with a five-year holding period so that an investment would reasonably be subjected to it by the investor.

Why is the lock-in period important?

  • It will assist the investors in maintaining their investment over time and gaining the advantages of long-term investing.
  • Lock-in periods are used by mutual funds to maintain liquidity while bringing about stability.
  • Lock-in periods can be useful if one wants to deduct the revenue from these investments from their taxable income.
  • For hedge funds, the lock up period allows the manager time to sell investments that would be difficult to liquidate or that might otherwise quickly unbalance their portfolio.
  • For start-ups or businesses issuing an IPO, the lock-in period aids in the development of a sound business model and demonstrates market resiliency.
  • The post-IPO lock-up period prohibits stock from being sold right away when share prices may be inflated and subject to excessive price volatility.
  • It’s a good idea to have a lock-in period for goal-based investments.

Investing in a home is a major decision that requires careful consideration of many factors. Most investors lack information and only respond to slight changes in the market. A lock-in period will encourage investors to commit to their investment for a while and benefit from long-term investing. Investments in mutual funds have lock-in periods to promote stability in the fund. If there is too much selling, there may be more redemptions, which could affect the fund’s liquidity. Hence, the lock in period will aid in maintaining liquidity. A lock-in period will prevent investors from selling their shares and maintain the stability of the fund’s assets. They act in favour of investors by doing this. so that stock investors can profit significantly from their investments. This is why mutual funds maintain market stability to protect the wealth of investors

What should I do after the lock-in period expires?

It is a good idea to have a backup plan in case the backup plan fails. After evaluating the investment’s performance, they should decide whether or not to redeem. Investors in mutual funds must assess the performance of their funds. Let us here take the example of ELSS funds and their lock-in periods.

1. Evaluate the fund’s performance.

ELSS funds assist with more than just tax reduction. They accomplish two goals at once: tax savings and long-term capital growth. Most investors just utilise ELSS funds as a means of tax avoidance. They redeem this investment to make an investment in a new ELSS fund when the three-year lock-in period has passed. To avoid paying taxes, they do this. But this limits the advantages for investors. ELSS funds make equity investments. Simply put, they are multi-cap funds with diverse portfolios run by knowledgeable fund managers. For the services, the fund manager charges a fee. To get the most out of their ELSS assets, it is advised that investors hold onto their investments for at least five to seven years.

Also Read Benefits of ELSS Mutual Fund

Equities can’t reach their full potential in just three years. Investors are advised to conduct a fund review after three years, nevertheless.

2. Choose whether to continue investing.

Investors can evaluate their ELSS fund investment after three years. Investors must do this by matching their objectives with the performance of the fund. The investor can keep investing in the fund as long as it is expanding and meets their financial objectives. It is best to sell this investment and put the money into a new ELSS fund if the fund’s performance does not meet the investor’s objectives.

3. Bring back the investment.

Investors shouldn’t base their investment tenure on the lock-in period. In order to protect investors’ interests, fund stability, and liquidity, a lock-in period is required. After three years, the lock-in period for ELSS funds ends.

Investors are encouraged to only redeem their holdings if they actually need the money. Investment redemption is acceptable in the event of a medical emergency or uncertainties.When one is getting close to a financial goal or the fund’s performance isn’t in line with the objective, investments can also be redeemed. If not, investors can continue to invest and benefit significantly from equity investing.

Once the lock in period has passed, investments made with ELSS funds do not have to be redeemed. But, after the lock-in time expires, an investment must be monitored. Only when a fund’s performance falls short of the investors’ expectations may investors redeem their holdings. or if they require money in case of an emergency. To avoid paying taxes, investors shouldn’t sell their holdings after the lock in period and switch to a new ELSS fund. The advice that we give is to stay invested in ELSS funds for 5-7 years to get significant benefit from equities.

Conclusion

A lock-in period places limitations on more than merely selling investments. Also, it gives investors a chance to increase their investment returns. A lock in term doesn’t define the tenure of investment. It is merely a limitation imposed by the AMC or firm to protect liquidity and uphold market stability. Now that you know some of the important details related to funds, open demat account with Angel One and start investing in stocks, mutual funds and a whole lot more!

FAQs

What is the lock -in period for mutual funds?

When a lock-in period is in effect, buyers of mutual fund units are not permitted to sell them. In most circumstances, the lock-in period lasts for three years.

Do all mutual funds have a lock-in period?

In India, there is often no lock-in period for mutual funds. Only tax-saving mutual funds or ELSS have a lock-in period of three years.

Is it mandatory to stay invested or withdraw funds even after the expiry of the lock-in period?

No, it is not required. At the expiry of the lock-in period, ELSS becomes like any other open-ended equity fund. Although it is recommended that you keep investing, you have the option of taking a partial or full withdrawal of your money.

Why is a lock-in period imposed on ELSS?

A lock-in period is put in place to force investors to take advantage of equity investments to the fullest extent possible and to preserve the stability of the fund. The least amount of time that the funds must remain invested in the equity market is three years.

What is the tax rebate that is available on ELSS funds during the lock-in period?

When you invest in an ELSS fund, you are eligible for a tax deduction of Rs 1,50,000 under section 80 C.

Do I need to invest in lumpsum for an ELSS fund?

No. For as little as Rs. 500, you can invest lump sum or through SIPs.