Should you book profits on your equity funds?

As the stock indices soar past previous life-highs, many retail investors seem to be deciding that enough is enough and booking profits on equity funds, as AMFI data show. It is certainly a sign of maturity that in a buoyant market, instead of letting greed take over and pour more money into equity funds, investors are looking to protect the returns they’ve already made.

But while not being greedy in a bull market is important, it is also critical not to jeopardize your long-term wealth creation plans through attempts at market timing. So, here are three factors to keep in mind if you’re booking profits on equity funds.

Premature exit

Selling equity funds at market highs and re-entering them when it bottoms may be the textbook way to maximise returns. But in real life very few investors are blessed with the sense of perfect timing that can help practice this. Even professional investors who’ve spent decades in markets struggle to identify market tops and bottoms while living through them. So, one of the biggest risks you take when you sell equity funds in a rising market is to exit too early and miss out on further upside.

The current bull market has been a good lesson that taking a purely quantitative approach to identifying a market top can backfire. In the past, based on empirical data on the Nifty50’s official PE ratio, dynamic allocation funds used to deem markets expensive when the Nifty’s PE ratio crossed 22 and think of it as cheap when it fell below 15.

But this indicator has proved a big red herring in the current bull market. Investors, who booked equity profits in February 2015 when the Nifty PE first crossed the 22 mark, would be quite bitter today as they’ve missed out on a 76 per cent Nifty upside since then. A combination of valuation, liquidity and behavioural metrics now appear to be a better gauge. Therefore, even if you’re convinced that the stock market is a bubble waiting to burst, make allowances for your predictions turning out to be wrong. Hold on to a minimum equity allocation at all times and book profits only on your excess holdings over and above it.

Low returns

No matter how disciplined you are, getting to a double-digit return on your equity fund portfolio is no easy task. Many investors who’ve persisted with the SIP route to equity funds in the past decade or so, still have only single-digit CAGR (compound annual growth rate) to show for it.

It is in the nature of the stock markets to frustrate you with two-way moves for years only to deliver big gains in a sudden burst spanning a few weeks. Rushing to book profits after on a short-term up-move can deprive you of the opportunity to make up for all the uncertainty you’ve endured over the years.

If booking profits on your funds, do it on the basis of long-term portfolio returns you’ve achieved and not absolute gains in the last six months or year. For investors who bought diversified equity funds in January 2008, CAGR returns on diversified equity funds even after this stellar rally average only about 9 per cent.

Delayed deployment

Jumping off the ship when markets are looking frothy is actually the easy part of market timing. The tougher part comes when you need to decide when to re-deploy that money.

Assuming that you’ve been investing in equity funds with specific long-term goals in mind, investing your equity profits into bank FDs or debt funds simply isn’t going to get you to your goals.

If you exit your equity funds because markets are expensive today, it will also be up to you to identify when they are cheap enough to invest again. Many savvy investors who exited smartly at market highs in January 2020 admit that they managed to re-deploy only a little of that at March lows. After a 30 per cent correction, they feared that the correction wasn’t over. In India, market rebounds from bear phases tend to be both swift and sharp, offering very little time for you to select stocks or funds to buy.

Given the above factors, when should you be certain about booking profits on your equity funds? Consider it in these situations.

Goals within three years: If the money you have parked in equity funds is for a goal that is likely to come up within the next 3-4 years, it is best to book profits on your funds today. Should a correction materialise, you’ll not have the time to wait out the bear phase and recoup your capital.

Past cycles show that when stock prices crash, a complete recovery from a bear phase takes 4-5 years.

Overshooting planned allocation: If you are working to a fixed asset allocation plan based on your risk profile and investing horizon, don’t hesitate to book profits on your equity funds to rebalance your portfolio, when allocations overshoot.

Wrong style or mandate: If you invested in funds that are ill-suited to your risk profile or long-term goals on an impulse, this is a good time to exit and switch into investments better suited to you.

NFOs, thematic or sector funds that you acquired in the spur of the moment may be particularly good candidates for profit-booking today.