How to redeem only profits from mutual funds?

Published: November 1, 2021 at 8:38 am

Last Updated on November 1, 2021 at 8:38 am

A viewer on our YouTube channel asks, “Sir, Kindly do video…how to redeem only profit from mutual funds without reducing unit’s (if we book profits our capital amount also reducing because units get reduced)”.

Experienced investors and regular readers of freefincal would immediately know that the answer to this is: No, it is not possible to redeem only profits from mutual funds (or shares) unless you are a fan of mental accounting.

Unfortunately, the term “profit-booking” – popular among traders- permeated investor and mutual fund communities. This does not literally mean removing (only) profits.

When you buy a bond or a fixed deposit or any interest-bearing instrument, you can separate the profit or gains – in this case, the interest – from the amount invested (the principal).

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Such a separation is only notional in the case of any commodity that you need to buy and sell at market price. If you buy one share or fractional units of a mutual fund, its current value = (no of units ) x purchase price + (no of units) x change in price.

This, of course, is the same as current value =  (no of units) x current price.

You can measure the gain (price change) associated with each unit, but you cannot sell that gain alone.

For example, you buy 25 MF units at a NAV of Rs. 10 per unit.  After a while, the NAV becomes Rs. 20 per unit. So your investment of Rs. 250 has doubled in value. Suppose you redeem Rs. 250. Mentally you have got your principal back, but the number of units has also decreased in half.

A redemption of Rs. 250 at a NAV of Rs. 20 per unit implies, 12.5 units have been sold back to the AMC. So you cannot pull out NAV appreciation alone, keeping the units constants.

Suppose you had invested in a dividend option of the fund, and the AMC declares a dividend of Rs. 10 per unit. You will receive an amount of Rs. 250 a dividend (which is taxable as per slab). The number of units you hold will still be 25, but the NAV of the fund after the dividend declaration will fall to Rs. 10 again (assuming the dividend was declared when the NAV doubled). So the value of your investment will only be Rs. 250.

Going back to the growth option example: 12.5 units were redeemed at a NAV of Rs 20 per unit. Now, these units were purchased at a NAV of Rs 10 per unit.

So using:

Redemption amount = (no  of units redeemed ) x purchase price + (no of units redeemed) x change in price

250 = 12.5 x (10) + 12.5 x (20-10).

The point is, every redemption we make will always have some amount of principal and some amount of capital gain or loss. You cannot have one without the other as we are buying units from the AMC when we invest and selling units to the AMC when we redeem.

This is hardly a problem. If you are going to redeem and use the money, there is nothing to complain about. If you are going to rebalance from equity to fixed income, there is nothing to complain about.  We recommend mutual fund investors avoid using the term profit booking or at least appreciate what it entails.

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