When equity market is at record high, should investors book profits?

Decision to sell should not be driven by market movement but only it involves meeting goals or portfolio rebalancing

Indian equity indices represented by S&P BSE Sensex hit the fresh record high in June 2021 thanks to pick up in the vaccination drive, falling coronavirus cases in India, better-than-expected domestic corporate earnings, accommodative stance of the Reserve Bank of India (RBI) and stimulus measures by the Indian government to boost the economic recovery.  In rising market, investors are often governed by euphoria and greed wherein they either invest more money or continue to remain invested for making more potential gains.

In trying to time to market and guided by emotions investors often make blunders and investment does not yield desired results.  Like for instance, investors invested on January 1, 2016 when Sensex was 26,610 points with a goal and investment horizon of four years and he made the gains of 12% when the index closed at 41,306 on January 1, 2020. However, with the market trending upward he decided not to exit and continue to remain invested. But markets suddenly crashed in March 2020 due to coronavirus crisis and he could earn only 3% returns as Sensex closed at 29,468 on March 31, 2020. Such market volatility and not timely investment decision of exit made it very difficult for him to attain his goal.  As equity market are unpredictable and highly volatile in nature, investors are often confused about whether they should book profits or stay invested?  While investing in equities should be for long term horizon, there are times investors should consider profit booking or rebalancing in their portfolio.  This article details some scenarios when investor can consider profit booking.  These are commonly observed scenarios, investors need to take their final investment decision in line with their risk appetite, goals, investment horizon and performance of the scrips they hold. Seeking a help of the professional financial advisor can also help to make the prudent investment decision.

• Consider booking profit while nearing financial goals – The main objective of investing is often to build the corpus required to meet several financial goals. While goals like retirement can be adjusted, funding child’s education or down payment of the house calls for money required on time. Hence, in such scenario it is always wise to consider cashing out gains.  Investors can consider booking profit when they are nearing the goal and transfer the money in safe investment avenue like bank deposit or liquid mutual fund.  This approach can help investors to benefit from the market and also protect the wealth in order to attain the required goals. 

• Partial profit booking in case of sharp market rally – Encouraging economic and market conditions often results in investor making a massive gain on their investment. This was evident in calendar year 2007, 2009 or 2021. Such situation provides opportunity to investors to book profits. In this scenario, investor can do partial profit booking and then re-invest in the market again whenever the valuation becomes cheaper.  Investors should however keep a note of the taxation and other cost involved while cashing out gains. 

• Book profit in case of mediocre performance of the underlying instruments – It is not possible that we will be investing in star performers. There are times we might have some underperformers in our portfolio which may not fetch the desired returns. Market rise often results in these underperformers to give descent returns and in this case, investor might be able to make some gains on their investment. In such scenario, investors can consider selling the underperformers and reinvest the money in better performing scrips. 

• Portfolio rebalancing which calls for “sell high” and “buy low” - Asset allocation is the essential to successful investing. Every investor will allocate money to different assets like equity, debt and gold and designed a target allocation based on their own risk-return profile.  A rangebound market will not alter the target asset allocation that investors might have set in line with their risk appetite. However, a market correction or rally alters the asset allocation. Portfolio rebalancing is strategy to adjust or rejig the portfolio by selling one asset and buying another to meet the target asset allocation.  Below case study will help to understand portfolio rebalancing.

CASE STUDY

Let us assume investors invested Rs 1 lakh each i.e., 50:50 ratio in equity and debt on 31 Jan 2019.  Equity is represented by Nifty 50 index while debt is represented by Nifty 10-year benchmark G-Sec Index.  In March 2020 when the equity market crashed the percentage allocation to equity and debt got altered from original 50:50 to 41:59 which requires investor to withdraw money from debt and invest more in equity to reach the target asset allocation of 50:50.  Further as the market rebounded from April 2020 to June 2021, asset allocation in equity and debt again changed to 63:37 which requires investor to rebalance their portfolio by booking profit in equity and investing in debt to align the portfolio to target allocation.

Source: NSE

Note:   Equity is represented by Nifty 50 index

Debt is represented by Nifty 10-year benchmark G-Sec Index

As seen in the case study above it is important to rebalance the portfolio which may call for profit booking to mitigate the risk and keep the portfolio aligned with your risk bearing capacity.  While rebalancing; keep a check on the taxation as capital gains on investment of less than one year attracts short term capital gains tax of 15% while capital gains earned over and above Rs 1 lakh after one year attract long term capital gains tax of 10%.  Investors should also keep a note of brokerage charges and other cost involved while selling equities.

Apart from the aforementioned factors, unforeseen emergency be it in form of loss of job, some medical emergency calls for cashing out some gains.  Investors can later on reinvest in the market.

Summing up

Investing in equity should also be long term but enjoying the fruits of investment which can help to meet crucial life cycle goals is equally important. Hence, there is need to book profits and have a well-planned exit strategy which is executed when market is at peak.  While the hopes of economic revival boost the overall sentiment, threat of new covid variants is imminent and hence investor may consider cashing out some gains and reinvesting at a cheaper valuation at a later date.  Investors should also take a prudent move when it comes to deployment of the booked profits in safer investment avenue which can be easily withdrawn and reinvested in equities again.  While selling keep a note of cost involved, taxation and risk-return appetite.