Any financial planner would advise you to “invest in equities for the long term”. But the basic question that arises is – how long is long term? Is it three years, five years, 10 years or, as legendary investor Warren Buffet says, “Our favourite holding period is forever”.
Well, for lay investors, ‘forever’ may not be possible because they invest money in equities to make sure that they are able to achieve their goals. For instance, you might be investing for a car or a house that you want to buy in five years.
So, it is important to realise that profit-booking is an important part of investment. And there are a couple of ways one can book profit. For that, the advice varies from stock experts to financial advisers, as the two communities play different roles.
Investment advisers feel that holding on to the entire equity investment can turn out to be a loss-making proposition. “Staying in equities for a long term is the key to building wealth. But this cannot be achieved if investors fail to book profits regularly,” said Gul Tekchandani, a market expert and investment adviser. “But before one sells, always remember to see the value of the stock. A simple way to do this is to study the price-to-earnings (P/E) ratio,” he added.
On the other hand, financial planners’ job is goal-oriented. They decide on investment, depending on what is to be achieved and when. They also take the risk appetite of the investor into account and, accordingly, allocate the money. As per them, profit-booking can be done at several stages.
Let’s assume that the investor’s equity portfolio is divided into large-cap, mid-cap and small-cap equally. “Profits can be booked when the proportion of the portfolio changes. It should be restored to the original allocation,” said Gaurav Mashruwala, a certified financial planner.
The key to profit-booking here is allocation. And this applies to mutual fund investments too. These changes should be made at least once a year. But if the allocation rises or falls by 15 per cent, the investor should realise profit.
Profit-booking also needs to be done if the person is a year or two years away from the goal. This decision depends on the value of the investment. If the stocks in the portfolio are getting overvalued, which may also mean that the market has risen considerably, then profits can be booked early. Else, it should be done around a year before realising the goal.
When it comes to stock market investment advisers, they believe in booking profit at every rally. These experts look at equity investment only as a tool to grow wealth.
The journey of the market is never linear. There are interim rallies or corrections every now and then. These experts suggest that investors should buy at these interim dips and sell during rallies. But this does not mean that the entire portfolio should be sold and then bought back.
This strategy is very stock-specific. For example, an investor purchases 100 stocks of a blue chip company at an attractive valuation for the long term. Investment advisers say when the market rallies, profit should be booked only on a small proportion of the investment. And the rest should be kept for growth. “The amount of stocks to be sold depends on the company’s valuation,” said Tekchandani.
But no matter how investors book profits, experts caution that they should not time the market. Huge losses can accumulate if one takes a call on the market movement and it goes wrong. “Stock-picking should be done after understanding valuation and putting trust in the management. Sell shares of a company only if you feel the valuation is becoming expensive,” said Mukesh Dedhiya, a certified financial planner.