Profit Booking or Market Timing – What are you doing currently?
After a roller-coaster ride in the last year, the volatility in the market is still prevalent. The markets seem to no longer be affected by the pandemic and have moved past it. With a sudden run-up in the share prices, investors are facing a dilemma – Should I be happy with Unrealised Gains or Should I book my profits? Emotions are always oscillating between GREED and FEAR.
There are 2 scenarios when an investor opts for profit booking – one is when there is change in the asset allocation and another is to re-enter the markets on correction.
Volatility in the market leads to a distortion in the asset allocation strategy adopted by investors. When markets go up, equity exposure in the portfolio tends to rise, whereas when markets fall, equity exposure in the portfolio is reduced. At such times, investors can rebalance their portfolio to recreate the pre-decided asset allocation mix.
Market timing is a strategy in which investors attempt to beat the market by predicting its movements. It involves switching between asset classes based on the outlook of the market. Thus the investor first attempts to sell and then awaits a correction to re-enter the markets.
While thinking about profit booking or market timing, people who invest with the aim of long-term wealth creation get carried away by short term profits and forget the purpose of their investment and the time horizon for which they had planned to invest.
Profit booking should be for asset allocation adjustment–
When the markets fell drastically in March 2020, the asset allocation of an investor would have undergone a huge deviation. At such a time, if an investor had rejigged his portfolio to match the asset allocation plan, the returns would have been higher. Check the below table to understand this more clearly.
The example shows recent market movements, in which coincidentally the market went up. There could be situations wherein market goes down too. At such times, investors will need to exercise patience and review their portfolios once a year.
Following an asset allocation-based approach pre-empts an investor from getting affected by distractions in the short term and at the same time, he/she can make wise decisions and reap benefits from opportunities provided by the market.
Timing the market may or may not be successful
As the markets began to fall in March 2020, there would be two type of investors in the market. Few of the investors, in anticipation of a further fall in the market, would have panicked and sold their investments, incurring losses. There would also be other type of investors who would have considered the market fall as an opportunity and invested during this time. Investors who sold their investments would be waiting for the ‘RIGHT TIME’ to re-enter the market. Since the market recovered very rapidly, these investors might have missed the opportunity. Whereas, the other type of investors who invested between Mar’20 and Jun’20, when the markets were down, would have made 50.5% returns up to Feb’21. Thus, an investor who is successful in timing the market can earn good profit from this strategy whereas an investor whose judgement goes wrong can also lose from market timing.
Transaction costs are involved –
When an investor carries out any transaction, there are certain costs that are involved in the process. These need to be evaluated and taken into consideration before taking any decision. The below table shows the various costs that an investor will have to incur if investments are sold within a span of one year.
# Generally, exit load is 1% of current value; ## Short term capital gains are 15% on gains. But since there will always be 10% long term capital gains tax, we have taken incremental tax of 5%
In our example, we have assumed a return of 20% on the investment. The total redemption cost increases or decreases as the return on investment rises or falls, respectively.
Equity delivers best returns over the longer period –
The potential of equity investment is to generate wealth over a very long period of time. The table below shows the rolling return and standard deviation of S&P BSE Sensex for different investment periods. Rolling return tells us the historical returns investors would have made (minimum and maximum), if they had held the investment for a specific period of time and standard deviation shows us how much the actual return deviates from the average return of that period.
Data as on 26th February, 2021Source: Ace MF
It can be clearly seen that as the investment tenure increases the minimum return from S&P BSE Sensex goes on increasing. Also, the deviation in the returns measured by the standard deviation decreases as the investment tenure increases.
One of the greatest investors, Mr. Warren Buffet, purchased his first share at the age of 11 and made his first billion dollars at the age of 50. Today at the age of 90, his wealth is worth $92 billion. So, it is clear from his example that wealth creation can only be done by allowing your equity investment to remain in the market for longer periods so that it can compound exponentially. Staying invested in equities and sailing through booms and busts is one of the key traits of successful long-term equity investors. However, make adjustments only if you are nearer to your goal or if you need to make adjustment as per your asset allocation plan.
You may also like to read: In Conversation with Dharmendra Satapathy
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.