Markets are High- Should you Book Profits?

As I write this, both NIFTY and SENSEX are close to an all-time high. Whenever the financial market is high, there are only three directions for its subsequent movement. First, it can go higher from present levels.  Second, it might remain at current levels and stabilize.  Or third, it might go to lower levels. Many investors are sitting on good gains since the March 2019 fall of stock markets. The current dilemma is to either cash out and book profits, or to wait for higher levels.  

Is it time to Book Profits?

Every investor is always struggling with diverse investment theories leading him to opposite directions. One says stay invested, other tells to book profits, and someone advises him to invest more. Unrealized gains will ultimately become profits only when we realize them. And what better time then now when markets are at an all-time high. With COVID vaccines getting rolled out, there is apparently some more good news lined up. Making use of stop losses, or Good to Trigger (GTT) Orders can be a good way to cash out while retaining the opportunity to benefit from further gains.

What to Cash Out

Any sensible investor would be having a diversified portfolio. This would include a fair mix of Stocks, Mutual Funds, Gold, Real Estate, and Debt Funds. All Asset Classes have different characteristics, and therefore we cannot subject them to a common philosophy. The very purpose of diversification is to balance the increase/decrease in one asset class with the corresponding opposite movement in another. Let us analyze the current situation in context of each asset class.

Booking Profits in Stocks

Presently stocks are the most obvious asset class for cashing out. The question for every investor is how to pick the stock to sell, and how much of it to sell. Each investor’s portfolio is different and the performance will be varying. Almost all stocks picked up during the COVID induced market crash are doing very well. Some stocks bought earlier would have completed one year of holding and therefore any gains from them will qualify for Long Term Capital Gains (LTCG). One can evaluate each stock on its merit and prefer to dispose-off those which qualify for LTCG.

Small Cap and Mid Cap stocks have rallied more than Large Cap. But due to their higher volatility, they remain a better choice to book profits. One can buy these back when the market corrects. It is also a good time to dispose off penny stocks, if you had bought any of these for short term gains.

Redemption in Mutual Funds

Mutual Funds reflect the value of their underlying asset.  Almost all Equity MFs have gained significantly in the current rally. The schemes are managed by professional fund managers who keep taking the appropriate Buy/Sell decisions for you. I will not recommend redemption of any Mutual funds unless you need money for some planned purpose. Further, you may redeem for the purpose of Portfolio Rebalancing and Readjustments. Those of us who continued with SIPs during the market crash time have benefitted the most. SIPs help us in averaging out the cost of acquisition, and I recommend that you continue with your ongoing SIPs.

In case you are holding only MFs in your portfolio and no stocks, then you may consider booking part profits in MFs. You need to review your portfolio to identify the under-performing scheme which you may redeem. I will advise that you continue to hold pure Large Cap, Mid Cap and Small Cap funds.

Book Profit in Gold Assets

The prices of gold saw a spectacular rise in 2019. Gold as an asset  has its own characteristics and it also has significant cultural sentiment in Indian context. The prices of Gold have already started to see correction. If Equity markets continue to perform well, which everyone is expecting, Gold prices may fall further in the short run. All those who entered Gold for short term gains may consider cashing out. Long term investors can continue to hold, as its prices may reflect its long-term historical performance. The Gold ETFs or Gold Mutual Funds may be considered for redemption. Sovereign Gold Bonds (SGB) are a better form to hold gold for the long term.

Real Estate- Hold and Wait !

The Real Estate sector has been under pressure since the demonetisation. The COVID crisis has severely impacted the Commercial Space also. I am personally not in favour of any excess accumulation of Real Estate. The performance of Real Estate Investment Trusts (REITs) during the recent market downfall has also not been very good, but they indicate a positive outlook. If anyone has been holding REITs, I will recommend that you continue to hold them.

Debt Funds

Whenever Equities perform bad, the debt sector does well, and vice versa. All Debt funds did well during the COVID crisis (barring a few schemes in high-risk categories). We park funds meant for the short and medium term in Debt instruments. As they provide security and modest returns, I will recommend that you continue to hold them as per your defined Asset Mix. Any redemption will create a re-investment problem, as entering the Equity segment at these levels is not advisable.   

How much to Cash Out?

It is not recommended to redeem all investments. The Tax Provisions exempt tax on Long Term Capital Gains to the extent of Rs 1 lakh every year. Therefore, the least amount that one should redeem is what lets you exploit the entire limit of tax exemption. You can roll over the capital gains through re-investment.

You should also rebalance the portfolio at least once every year. This is probably the right time to do this. Each asset class in your portfolio would have performed differently. Now is the time to skim profits from the classes which have outgrown their defined proportion. You can plan to redeem that much as would help restore the pre-defined asset mix.

What to do with Redeemed Funds

If you need funds for any pre-defined purpose, then this question is not relevant. However, if you are only trying to make good of the present market levels, then the re-investment option must be evaluated.

Rebalance Portfolio. At the macro level, your pre-defined Asset Mix should guide you. If your Equity has now become 5% more than the defined allocation, then you should shift these funds to Debt. Similarly, the balance should be restored for each sub asset category within an asset class. For e.g., surplus in Small Cap can be shifted to Large or Mid Cap.

Attractive Instruments. The specific item to be picked in each class must be evaluated on its fundamental strength. One instrument which is very attractive now is REITs. I feel that in the long run, the commercial space will continue to gain. It may not be possible for all businesses to adapt to the Work from Home philosophy.

Mode of Re-investment. You can re-invest in stocks in bulk during market corrections. The mode of investment in Mutual Funds is recommended to be through SIPs. You can use Liquid Funds for temporary parking of redeemed funds. Any investment in Debt Funds can be done in bulk immediately.

Recommendations

The summary of recommendations is: –

1. Book part profits in Stocks.  No need to redeem Mutual Funds if you do not need the money now.
   
   
2. Rollover the Long-Term Capital Gains and exploit the tax exemption limits up to Rs 1 lakh.
   
   
3. Carry out your annual portfolio rebalancing and restore the pre-defined Asset Mix.
   
   
4. Plan for the re-investment of redeemed funds before cashing out.