Most of you will be aware of the increasing popularity and people’s interest in mutual funds. You might encounter many terms like SIPs, mutual funds, SWPs, lock-in period, and much more. Have you ever wondered what these concepts are and what’s the reason behind their popularity and increased demand?

Well, these are all investment-related terms. Moreover, investing in mutual funds has now become one of the most popular methods to grow your money steadily yet stably. But, before you invest, it’s important to understand the concept of a lock-in period. Many mutual funds come with a lock-in period. This is most commonly seen in tax-saving options.

The Lock-in Period in mutual funds means you can’t withdraw your invested money for a specific duration. This rule often confuses investors and worries them about this. In this article, we’ll explain what a lock-in period is, the reasons it exists, and what advantages it offers. Knowing this concept may help you in making investment decisions.

What is the Lock-in Period in Mutual Funds?

To simply make you understand the term lock-in period, all we need to say is that it’s a minimum time period your investment must remain in the scheme before you can withdraw it. During this period, redemption or selling of units is not allowed.

If you want an example, you may consider Equity Linked Savings Schemes (ELSS). It has a lock-in period of three years. This feature ensures that investors stay invested for a specific duration. This helps them benefit from long-term returns. The lock-in period can vary depending on the type of mutual fund. Also, some funds come with no lock-in at all.

Why Do Mutual Funds Have a Lock-in Period?

Most commonly, investors have one important question: Why are some mutual funds subject to a lock-in period? Even though the answer may be apparent, the term and concept of a lock-in period aren’t understandable to many people. The lock-in period mandates investors to keep their investments in the accounts for a minimum period of time. This allows benefits to both the investors and the fund managers. Here are some of the major reasons:

Promotes disciplined investment: When there’s a lock-in period, people have control over impulsive withdrawals. When you know you can’t withdraw your money, you’ll get encouraged to keep the amount invested for long-term financial goals.
For better fund management: A Lock-in period gives fund managers time to invest efficiently without worrying about sudden and unwanted withdrawals. You can see better fund management through a lock-in period system.
Regulatory compliance: Tax-saving funds like ELSS have a lock-in period as per government rules to claim Section 80C benefits. This allows investors and fund managers to take advantage of government benefits.
Helps in constant wealth creation: Longer investment horizons generally provide better compounding and higher returns. This means you can have constant and undisturbed wealth growth through these investments.

Types of Mutual Funds with a Lock-in Period

Well, it’s important to mention that not every mutual fund comes with a lock-in period. However, some categories have mandatory restrictions on withdrawals for a specific duration. These are mainly designed to encourage long-term investing, and sometimes they also provide tax benefits. The main types include the following:

Also Read: Is Perpetual SIP Different from Normal SIP?

Equity Linked Savings Scheme (ELSS)

ELSS funds are tax-efficient mutual funds that have a compulsory 3-year Lock-in Period in mutual funds. Investors can claim deductions under Section 80C of the Income Tax Act. This can be up to ₹1.5 lakh per year. It has one of the shortest lock-in periods among tax-saving schemes.

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Close-Ended Mutual Funds

The investments of closed-ended funds have a fixed maturity period, typically ranging from 3 years to 5 years and even more. Once you invest in this, you cannot redeem any units until the maturity of the scheme. Most closed-end funds are launched with a New Fund Offer (NFO) and then listed on a stock exchange.

Fixed Maturity Plans (FMPs)

FMPs are quite similar to fixed deposits, but are in a mutual fund format. Also, they come with a predetermined maturity date. Investors must stay invested until maturity to get the expected returns. FMPs are suitable for conservative investors seeking low-risk and predictable outcomes.

How Long is the Lock-in Period in Mutual Funds?

The time frame of the lock-in period in mutual funds is based on the kind of scheme you will be choosing. Let’s clear the thing with an example. The Equity Linked Savings Scheme (ELSS) has a three-year lock-in period. This is considered the shortest among all the tax-saving options under Section 80C.

For closed-end mutual funds, the Lock-in Period in mutual funds normally equals the maturity period. This can typically range from three to five years or even more. Fixed Maturity Plans (FMPs) will remain in a Lock-in Period in mutual funds until their stated maturity.

However, when you talk about open-ended mutual funds, they generally do not have a Lock-in Period in mutual funds. You’re eligible to redeem the funds whenever you want.

Long-term Advantages Linked To Lock-in Period in mutual funds

If you also think that the lock-in period in mutual funds is just a restriction, then you’re wrong. It offers several long-term benefits that can help you in your financial planning. Here are the major advantages:

Duration of compounding: The longer you stay invested and compounding your returns, the greater the potential and outcome to grow your wealth.
Reduced possibilities of emotional withdrawals: The lock-in period doesn’t allow you to make quick and emotional withdrawals during a market decline. This necessitates you to stick to your plan.
Possibility of better returns: Over long periods, equity markets have performed strongly and show a greater chance of improving return outcomes.
Long-term goal investment: Lock-in Period in mutual funds are aligned with long-term retirement, children’s education, and other long-term goals in mind. They also keep your investment untouched until you need it.
Tax savings with growth: Like most tax-saving funds, such as ELSS, investors can receive the benefits of Section 80C and potential future betterment through long-term capital growth.
Better overall management of funds: Fund managers can have better planning possibilities for investments, with no pressure from redemptions. This allows them to appropriately plan investments, ensuring better overall portfolio returns.

Limitations Related to Lock-in Period

Though the Lock-in Period in mutual funds has many advantages, there are also some limitations that investors will need to keep in mind before investing:

No Partial/Possible Exit: Most lock-in options, such as ELSS or closed-ended funds, do not allow for partial or early withdrawal before the period expires.
Opportunity Cost: Lock-in investment does not allow for switching or redeeming of your funds until the lock-in period is over. This can be a major issue when better options arise, or poor market conditions change.
Market Risk Still Exists: Although you are investing continuously, the investment is still subject to changes in the market. Your returns are not guaranteed. They could be high or low as per the market conditions.
Limited Flexibility: The Lock-in Period in mutual funds does not allow for rebalancing or alterations in your portfolio during the investment. This can limit your ability to amend your overall financial planning.

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What To Do After the Lock-in Period Expires?

After your lock-in period in mutual funds comes to an end, you have several options to manage your invested money and funds effectively:

Redeem your investment: As it’s your money, so if you would like to take some money out of your mutual funds for a personal goal or any expenses, you can do so. However, if you wish to redeem, you will still want to confirm the current market value and assess when you can redeem your investment.
Stay invested for growth: Even when the lock-in is over, you may want to stay invested in the mutual fund to continue taking advantage of long-term compounding. In fact, you can choose to do this even if you have time to achieve your financial goals.
Switch funds: Assuming the mutual fund has not performed as you hoped, you may easily switch to another mutual fund that performs better as per your risk-taking potential. This will allow you an opportunity to consider the potential fund options and select the right one for your benefit.
Start a systematic withdrawal plan (SWP): Another option is to convert your investment into an SWP. This is done to have a regular income from one source. Here, you can withdraw a fixed amount of money at a predetermined period of time.

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Conclusion

Lock-in period in mutual funds are a key feature of mutual funds because they encourage long-term investments and financial discipline. With a lock-in period, access to your funds is restricted for a specific period of time. However, it can ultimately be beneficial to an investor, with benefits such as tax savings, higher returns, and consistency.

Always remember to check the lock-in period in mutual funds before investing. This is important to do when you’re choosing an investment method. Also, it’s suggested that you should not invest funds that you believe you will likely require in the short run and plan for liquidity.

Familiarizing yourself with lock-in periods in mutual funds will help investors make informed decisions about their investment. Also, you can get the most out of your investments.