The return on the CNX Nifty in March 2014 was nearly 7 per cent. To put this in perspective, the returns during January-March 2014 was approximately 5.5 per cent. The one-year return was 17 per cent with the first six months returning 3.5 per cent.

This suggests that the stock market can be volatile; it can prevent you from achieving your life goals.

After all, if an index can move up 14 per cent between September 2013 and March 2014, it can decline just as quickly and claw back your portfolio’s unrealised gains!

Volatility hurts Higher your investment capital, lower the return you require to accumulate the desired wealth at the end of your investment horizon.

Likewise, higher the investment return, greater the chances you will achieve your investment objective. But you should protect the annual gains in your portfolio to achieve your investment objective. Suppose you invested ₹1,000 in April 2003. If you simply accumulated all the gains in your portfolio, your investment would have grown to ₹6,275 by December 2007.

A year later in December 2008, the sub-prime crisis would have wiped out a significant proportion of your unrealised gains — your investment value would have fallen to ₹3,253.

Now, this investment experience has two important consequences. One, it shows that you have to take a lot more effort to accumulate gains than to lose acquired wealth.

This makes it difficult for you to achieve your life goals, especially if you have a bad investment experience as you near your investment horizon.

And two, such losses can lead to regret and, hence, drive you to take irrational decisions.

For instance, large losses in 2008 prompted many individuals to shift from equity to bank fixed deposits; the latter offers stable returns but does not beat inflation. So, avoiding equity investments is not a solution to reducing your portfolio’s volatility risk. Rather, locking into gains on your equity investment is.

Automatic process Your profit-taking strategy should consider two issues. How to take profits? And how much profits to take? You should have an automatic process to make profits.

Your decisions may be questionable when you are stressed. And you will, indeed, be stressed when the markets are volatile. You can employ the following strategies to automatically take profits.

First, buy investment products with automatic rebalancing process. Take the National Pension System (NPS).

If you choose the Auto Choice - Lifecycle Fund, the fund manager will automatically annually reduce your equity and corporate bond allocations from age 36 such that you have 80 per cent in government bonds when you turn 55.

This process locks into unrealised gains in your equity investment; note that your bond investment will still be exposed to risk, though lower than equity.

Second, you can buy the dividend option of mutual funds. In this case, the fund manager may return your share of the fund’s profits to you when she believes that the market is overvalued.

This helps you shift the burden of taking profits on your investments to the fund manager, who is better equipped than you are to gauge the market movement.

And third, you can set up systematic withdrawal plans on your mutual fund investments.

This will help you continually take out profits from your investment without being swayed by the current market movements.

Realise gains The automatic profit-taking process, if you choose to create one, should take profits whenever unrealised gains are in excess of annualised return you require to achieve your investment objective.

Besides, take profits if you are gripped with anxiety about your investments. While large unrealised gains can hurt your investment health, anxiety can hurt your physical health.

And as a rule, do not harm both.

The author is the founder of Navera Consulting. Feedback may be sent to portfolioideas@thehindu.co.in

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