Should investors book profit now from equity market?

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Highlights

Booking profits can give extra cash but, lack of proper plan to reallocate and reinvest them could turn into a big headache for investors

The question on most investors' minds today is what next for the equity markets. It's been an eventual journey over the last year-and-a quarter for the investors, especially for those who remained invested during this period. For those, who wanted to wait and time the markets, mayn't have enjoyed this ride. After a huge crash across the geographies, equity markets have discounted the worst i.e., near-simultaneous lockdowns and began to price-in the revival (due to the most-coordinated liquidity measures). Of course, despite what it looks like a one-sided movement, it was pierced with volatility arising out of the very participants' doubts through the demand restoration, supply constraints, inflationary pressures, virus variant mayhem, vaccination drives, etc. At each of these instances, the market seemed to peak only to deceive with further gains. Just as the doubts turned hoarser, the markets sprang back with a further vigour. This was substantiated with numerous fresh narratives resulting in rotation of sectors and momentum across them.

The markets remained dichotomy to the actual economy especially in the early stages of the equity recovery. The macros didn't seem to provide much impetus with a part of the economy still struggling to get back to normalcy. But markets are, as always, forward looking and they realized the possibilities particularly in terms of the corporate adaptability, cost cutting and thus not just the survive but began to thrive in these difficult times. This has been the feature of this market rally which is very much the characteristic of equity markets.

So, should one focus on booking profits now? Last week I'd spent this space for describing how and when to perform rebalancing of the portfolio. So, why should one book profits at the first place. It could be part of a well-planned strategy i.e., as per the goal-based planning. In this, the investor as and when reaches towards the goal, the portfolio is resized i.e., allocation towards equity is reduced as one moves to cash and other safer (lesser volatile) avenues. This could be a proactive approach where part of the equity exposure is trimmed at a pre-defined rate so that the returns are protected or moved to another bucket which addresses the planned goal.

At times of raging bull markets, like that of today, the returns arrived could be higher than planned and so the corpus generated is arrived quicker or earlier than planned. Such moments are like a windfall and so it's a good idea to book profits and move to a fixed income-based investment to use them for the planned goal. It also provides an optionality to the investor to prepone the goal excepting those of children's education or marriage. This also helps the investor revisit their goal in terms of the corpus planned especially for retirement where they could revise if the monthly pension/income could be increased as the desired corpus is achieved earlier than planned.

The other is a well thought out framework in managing a portfolio where the weightage of the assets are defined and sticking to that. So, the outperformance of the equities could overgrow within the portfolio making the allocation higher than desired. At these instances, the investor is forced to reduce the equity allocation and diversified into the other assets proportionate to the existing plan. The portfolio was designed keeping in mind the risk appetite of the investor and so the shaving of the gains is seen to protect the investor from the overgrown imminent risk. This is part of the rebalancing strategy.

However, investors needn't book profits purely because the markets have shot up as the reinvest of retained gains is another problem. The risk of reinvestment could turn a bigger headache as they mayn't have a plan of what to do with the gains. These reactionary measures could backfire if done improperly or unplanned as the reinvested capital may lead to uncharted risk. So, it's ideal to not book profits, if there's no action plan of what to do with them. Again, as I've begun this article about the experience of the investors who have remained invested over timing, these booked profits if tried to be timed may not translate to better returns.

While booking profits not only gives extra cash to the investors, but also creates a responsibility of proper re-allocation. Legendary fund manager Peter Lynch once said: "Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves." The other way to ensure timing risk elimination could be to expose the gains to a hybrid allocations or even dynamic asset allocations which compliment the investor's investment thesis. Timing here becomes a non-influencer and helps the risk to be diversified, while readjusting as the market evolves.

(The author is a co-founder of Wealocity, a wealth management firm and could be reached at [email protected])

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