What is Lock-in Period in Mutual Funds?

A lock-in period is a feature of certain mutual fund schemes like tax-saving ELSS Funds and other close-ended schemes that restricts withdrawals for a fixed duration. It is primarily added to promote long-term investing, discourage early withdrawals, and protect potential tax benefits.

Not all mutual funds allow you to withdraw your money whenever you want. While most open-ended schemes offer easy liquidity, some mutual funds require you to stay invested for a fixed period before you can redeem your units. This is called a lock-in period in mutual funds. 

If you’re new to MF investing or simply confused by all the jargon, read this guide. We simplify the meaning of lock-in periods in mutual funds, on which schemes they apply, and why they’re important. 

Lock-in period in mutual funds is the defined period during which you cannot withdraw/redeem your MF investments from the scheme. Simply put, it is the minimum duration for which you have to hold your investment.

A lock-in period applies only if it is outlined in the scheme information document, which also states the duration and terms of the lock-in period for the fund clearly. Most open-ended mutual funds don’t have a lock-in period - meaning you can buy and sell their units at any time (but exit loads may apply as per SID).

As mentioned earlier, there are mutual funds with no lock-in periods. Lock-ins are generally used for specific types of funds where restricted withdrawals are a part of the structure. 

Lock-in periods in mutual funds apply to the following types of schemes:

Note: Solution-oriented funds, such as children's and retirement funds, also generally have a 5-year lock-in period (or until the child attains 18 years of age/the investor reaches the specified retirement age, as applicable). SEBI has introduced Life Cycle Funds to replace solution-oriented funds. AMCs that choose to continue existing schemes as legacy schemes cannot launch 20-year Life Cycle Funds.

Now that you know what a lock-in period is in mutual funds, you might be wondering why it is needed. Let’s understand the logic behind lock-in periods in mutual funds better:

1. Encourages You To Stay Invested for the Long-Term

The main objective of a lock-in period in mutual funds is to encourage long-term investing discipline. Keeping your MF investments in for a fixed duration may help you stay focused on long-term financial goals instead of making investment decisions based on short-term market movements. 

2. Prevents Impulsive Exits During Market Volatility 

During periods of market volatility, investors may feel tempted to redeem their investments. A lock-in period in mutual funds prevents early withdrawals, helping you avoid making decisions based only on temporary market fluctuations. 

3. Fund Management Stability

A lock-in period in mutual funds may also give fund managers greater stability because they do not have to manage frequent investor redemptions. This allows them to focus on managing the portfolio according to the scheme's investment objective. 

4. Potential Tax Benefits

Lock-in periods in ELSS funds may also offer tax benefits (apart from the 80(C) deduction on the principal invested). Since ELSS funds keep your investment locked for 3 years, capital gains from the same (if any) may attract LTCG when you finally redeem them. LTCG rates stand at 12.5%, which is lower than STCG of 20%.

Before we cover possible actions you may take after the lock-in in mutual funds ends, here’s what you need to remember:

• It is not mandatory to redeem your investment after the lock-in period ends.
• You should assess the performance of the scheme before deciding whether to redeem/continue investing.

Here are some options on how one can proceed once your mutual fund lock-in period ends:

1. Redemption

If the fund underperforms or if you need the investment to meet emergencies, you may decide to redeem the investment after the lock-in period ends. However, please note that for SIPs in ELSS funds, the lock-in of 3 years is applied separately to each installment. 

2. Stay Invested

Lock-in period ending in MFs doesn’t automatically mean you’ll have to redeem your units. If the fund performs well and still aligns with your objectives, you may choose to continue with the investment even after the lock-in period ends.

For closed-ended funds listed on recognised stock exchanges, you can buy and sell the units of the scheme on the stock exchange itself. 

Lock-in period and exit load are often confused, but they are not the same. A lock-in period means you cannot redeem your mutual fund units before a specified period. It is mandatory for certain mutual fund schemes, such as ELSS. 

Exit load in a mutual fund is simply a fee that’s charged for leaving the fund early. For instance, schemes may charge nominal exit loads of around 0.5%-1% on redemptions made within 1 year from the date of investment. 

Unlike a lock-in period, you can still redeem your investment, but the applicable exit load is deducted from the redemption amount. Please understand that exit loads and minimum timeframes vary from scheme to scheme and are mentioned in the SID. 

Understanding the lock-in period in mutual funds can help you choose schemes that match your investment goals and liquidity needs. Since not all mutual funds have a lock-in period, it is important to check the scheme details before investing. Always read the Scheme Information Document (SID) carefully to understand the investment terms and conditions. 

1. What happens to my MF units after the lock-in period ends?

When the mutual fund lock-in period ends, you are free to sell your units and redeem your investment. However, you may also choose to continue with the investment if the scheme is performing consistently. 

2. Can I withdraw from my MF investments before the lock-in period ends?

No. Schemes with lock-in periods do not allow investors to withdraw before the mandatory lock-in duration ends. Consider building an emergency fund for sudden, emergency expenses so that you don’t face liquidity issues when investing in a mutual fund with a lock-in period. 

3. What is the purpose of the lock-in period in mutual funds?

The main purpose of mutual fund lock-in periods is to prevent investors from selling early. It is aimed at helping cultivate mid-to-long-term investing discipline and prevent investors from liquidating investments based on short-term market fluctuations. 

4. How does the lock-in period apply in ELSS funds?

In ELSS funds, there is a mandatory lock-in period of 3 years. This lock-in window applies separately to each SIP installment. In other words, you can withdraw each SIP installment only after 3 years from its date of investment. 

But if you invest through a lump sum, the 3-year window applies to the entire investment at once.