Lock in Period in Mutual Funds: Good or Bad for You?

When you put money in a fixed deposit, the bank promises to pay interest for a certain period. In the same way, some mutual funds have a rule called the lock-in period. During this time, you can’t take out your money. It’s like keeping your money locked so it stays invested for a certain number of years.

This lock-in period means you cannot withdraw or sell your investment before the set time ends. The aim is to encourage long-term investing and reduce panic selling during market ups and downs. Even if your fund performs well, you must wait till the lock-in ends. This can be helpful, as it gives your money more time to grow. However, it also means you should invest only what you won’t need soon.

In this article, we will look at the lock in period meaning, why mutual funds have lock in period, the comparison between SIP and Lumpsum on Lock in period, impact on returns and withdrawals, and others. Let us continue to know more about lock in period.

What is Lock in Period in Mutual Fund?

A lock-in period is the time that you need to keep your money in a mutual fund without taking it out. During this time, you can’t sell or move your investment. Mutual fund companies set this rule to help people stay invested longer and avoid making quick decisions when markets go up or down. Most of the open-ended funds don’t have a lock in period. You can buy or sell anytime. Only some types of mutual funds have different lock-in periods.

• For ELSS funds, they are also known as tax-saving funds that lock your money for 3 years. You cannot withdraw before 3 years, and this helps you save tax and grow your money over time.

• For Fixed Maturity Plans (FMPs) that are debt funds where you keep money locked until the fund matures. This helps you get steady returns by holding debt investments until the end.

• There are Closed Ended funds that lets you to invest only during a fixed period and you must wait until maturity to redeem. This lock-in helps fund managers to allocate capital well.

Why do Mutual Funds have a Lock-in Period?

We wonder why they impose a lock in for the invested amount, what could be the reasons behind it? Let’s explore those:

• Encourage Long-Term Investing: A lock-in period helps investors to stay invested for a longer time, which can make the invested money compound over time. It discourages people from withdrawing money quickly and provide investments enough time to grow. Long-term investing also reduces the impact of short-term market ups and downs on your returns.

• Allows Fund Managers to Focus on Performance: When investors cannot pull out money instantly, fund managers get more freedom to plan and manage the fund better. They don’t need to hold extra cash to meet obligations. This stability helps them take long-term decisions and plan their allocation accordingly and deliver better returns.

• Supports Tax Benefits: There are tax benefits attached to lock in periods. Let’s take Equity Linked Saving Schemes (ELSS) as an example that come with a three-year lock in period, as they offer tax deductions under Section 80C. The lock in period ensures investors to keep invested in the fund for a minimum period and benefit from long-term investing while enjoying tax savings at the same time.

• Reduce Emotional Investment Decisions: The Lock in periods stop investors from reacting emotionally during market highs or lows. People often panic when markets fall and withdraw money instantly. The lock-in prevents such an immediate move and encourages disciplined investing, while it leads to better returns over time.

• Maintain Liquidity for Fund Planning: Some funds, like close-ended or ELSS, use a lock in period to manage cash flows better. Knowing that money will stay in the fund for a certain period helps fund managers to plan investments and make more confident decisions to match the fund’s goal and maturity period.

Can You Break the Lock in Period in Mutual Funds? 

Unlike fixed deposits or other flexible investments, mutual funds with a lock in period do not allow early withdrawal. Once you invest in such a scheme, like an ELSS or a close ended fund, you must stay invested until the lock in period ends. This rule applies even during the investor’s emergency period or if the fund underperforms. You can’t redeem or switch the units before the period is over.

Lock in Period for SIP vs Lumpsum Investment

We will look at the some of the differences between SIP and Lumpsum during Lock in period, here are as follows:

Impact of Lock in Period on Returns and Withdrawal Flexibility

As we looked into the differences of lock in period for SIP and Lumpsum, we will understand how lock in period impact returns and withdrawals when invested:

Impact on Returns:

A lock in period aids your fund investments growth by keeping invested in the fund for a certain period. Since you can’t withdraw early, you avoid emotional decisions like panic selling during market falls. This lets your investment to stay on track and benefit from compounding over time.

Fund managers also get more stability, allowing them to make better long-term choices. As a result, you have a better chance of earning higher returns by staying invested throughout the lock in period. This action encourages investors to make a disciplined approach towards investing that often works better than chasing quick gains or reacting to short-term market changes.

Example:

Ravi invested Rs. 2,00,000 in an ELSS mutual fund with a 3-year lock in period. In the first year, markets decline, and many investors exited other funds in panic. But Ravi couldn't withdraw due to the lock in.

Over the next two years, the markets recovered, and his fund grew steadily. By the end of a three year period, his investment would’ve grown to Rs. 3 lakh. If he had withdrawn early like others, he would have missed out on these gains. However, doing SIPs over a lump sum would be better to get rupee cost averaging.

Impact on Withdrawal Flexibility:

While the lock in period is intact, it can help you earn better returns, while it limits your ability to use your money when you want. Once you invest in a fund with a lock in, you can’t take it out until the time period ends, even if you need money urgently or the fund isn’t performing well.

This can feel restrictive, especially during emergency times or if you find better investment options elsewhere. That’s why it’s important to invest only the amount you can afford to lock away and match it with long-term goals where you won’t need that money immediately.

Example:

Meena invested Rs. 1,00,000 in an ELSS fund to save tax. A year later, she needed funds for a medical emergency, but her money was locked in for three years. Since she couldn’t withdraw, she had to take a personal loan at a high interest rate. Even though her investment later gave good returns, the lock in caused stress when she needed quick access.

This shows how lock in periods can reduce flexibility. If Meena had kept an emergency fund separately, she could have handled the situation much better.

Advantages of Lock in Period

After understanding the impact of lock in period on returns and withdrawals, we will look at some of the advantages of lock in period:

• Promotes Discipline: The lock in period improve discipline in investors while keeping their money intact. This can help them to stay focused on long-term financial goals rather than chasing short-term gains.

• Avoid Panic Exits: Keeping invested will keep the investors from making any emotional decisions during market downturns and avoid panic selling. Over the period, when the market shows an uptrend, the fund can perform; thus, it's better for long-term investors.

• Empowers Fund Managers: Fund Managers will benefit the most from lock in periods, as they can manage money more efficiently, as they don’t have to worry about unexpected redemptions, while enabling them to make long-term investment strategies.

• Reduces Volatility: During market volatility, investors often move to safe-haven assets like gold or choose to keep cash, and this sentiment can trigger sudden outflows. So, lock in can help funds to stay stable during market fluctuations and ensure better performance over time.

• Consistent Growth: By holding investments longer, the compounding factor works better, thus increasing chances of steady returns and long-term wealth creation for investors.

Disadvantages of Lock in Period

As we looked into the advantages, we will look at some downsides as well:

• Limiting Money Access: During the lock in period, you can’t withdraw your money even if you need it urgently. This lack of flexibility can be a problem if you face an emergency or a better investment opportunity comes up. You must wait until the lock-in ends to use your funds.

• Fund’s Poor Performance: If the fund performs badly during the lock in period, you cannot exit or switch to another fund. You’re stuck with it even if it’s not doing well. This can impact your overall returns.

• Opportunity Cost: When your money stays locked in, you can’t move it to a better-performing fund or asset. If markets change or new opportunities come up, you have to wait. This can lead to lost chances where your money could have earned higher returns elsewhere during that time.

• Doesn’t Suit Short-Term Goals: A lock in fund doesn’t work well if you have short-term financial needs. Let’s say, if you need money in a year for a vacation or a major purchase, you won’t be able to access it.

• Change in Financial Goals: Sometimes your financial goals or plans may alter after investing. But with a lock in, your money stays in the fund, and you can’t adjust your investments quickly. This lack of flexibility may lead to regret if your life situation or goals change during the lock in period.

How to Check the Lock in Period of Your Mutual Fund Investment

As we looked into the advantages and disadvantages of the lock in period, here are some ways to check the lock in period before investing in a mutual fund. If you haven’t started or are looking for a new investing experience, you can invest through Rupeezy after necessary KYC compliance to make your investing journey smooth.

Here are the ways in which you can check a mutual fund lock in before your investment in the fund:

• Check Fund Papers: You should read the Scheme Information Document (SID) or Key Information Memorandum (KIM). These papers provide you the actual picture of whether your fund has a lock in period or not. Look in the “Load Structure” or “Key Features” part to find it.

• Visit Websites: Go to the AMC’s official website or the AMFI website. These sites often show product details, including whether there’s a lock-in period.

• Consult your Financial Advisor: If you still feel confused, talk to your financial advisor or mutual fund distributor for clarity.

Before you invest, check the lock in rule. It’s very important if you might need the money early.

Things to do After Lock in Period

• Review your financial goals: Check if your investment goals match your current needs.

• Build or top up your emergency fund: You can use part of the money for financial safety.

• Switch to better-performing funds: You can consider moving to funds that match your investment goals and can perform better.

• Rebalance your portfolio: You can adjust your overall investments to maintain proper asset allocation.

• Goal Specific: You can use the funds for planned short-term goals like spending on a trip or gadget. If it is a long-term goal, then you can focus on investing for buying a home or saving for retirement.

Conclusion

As we conclude, we looked at the lock in period, which keeps your money invested for a fixed time, which helps you to grow and avoid panic exits. It helps to increase financial discipline and support long-term goals. But it also limits access in emergencies. Always check the lock in rule before investing and plan your goals accordingly to use the money wisely. Always consult your financial advisor before investing.

FAQs

Q. Can I withdraw my mutual fund before lock-in period?

No, you cannot withdraw your mutual fund investment before the lock in period ends. The money stays locked until the fixed period is over.

Q. Does SIP have a locking period?

Yes, in funds with a lock in period like ELSS, each SIP installment has its own 3 year lock in from the date of investment.

Q. What is the 3 year lock-in period?

The 3 year lock in period is common in ELSS funds. It means your money stays invested for 3 years, and you cannot withdraw it before that period.

Q. Can I withdraw money from mutual fund within 1 year?

Only if the fund has no lock in period. For funds like ELSS, FMPs, or closed ended funds, withdrawal within 1 year is not allowed, so check properly before investing.

Q. How to redeem lock-in period mutual fund?

Once the lock in ends, you can redeem the units that are unlocked by placing a withdrawal request through platform or fund house.

Q. What is the validity of lock-in period?

The lock in period stays valid for the set number of years from the date of investment. For example, it is 3 years for ELSS, after that, units become redeemable.