Locking in gains
How to protect your profits in this stock market
Stock markets have rallied sharply over the past few months. The S&P BSE Sensex, the broad market indicator, touched an all-time high of 31,311 on June 19, 2017. It has delivered a year-to-date return of 16 per cent (till June 29). The S&P BSE Midcap and the S&P BSE Smallcap indices have risen 21 per cent and 27 per cent, respectively, over this period.
This means many people will be sitting on decent gains and wondering whether to stay put or cash out. It is not an easy choice. If the market continues to move higher after they book profits, they will find themselves entering at a higher valuation, which will affect their portfolio returns. Or, they may remain invested, but markets may correct. The short point is that timing a market exit and re-entry requires a fair bit of experience and expertise and is, therefore, considered beyond the scope of most retail investors. This is especially true in the current market as experts are upbeat about equity markets over the long term but are not ruling out short-term gyrations due to high valuations, uncertainty over implementation of the goods and services tax and foreign institutional investor flows.
"GST might lead to savings in the cost of doing businesses. Further, GST, as well as demonetisation, will lead to a significant reduction in parallel economy over a period. At the same time, savings are moving from physical to financial assets. All these can lead to far higher growth over a long period. But from a shorter term perspective, the valuation looks high. However, as they say, markets can remain irrational for more time than you can remain solvent," says Abhishek Anand, Fund Manager at Centrum Broking.
Despite the short-term uncertainty, experts are not advising investors to go underweight on equity. "We are not advising investors to go underweight on equity. We are strictly following the asset allocation guidelines," says Nishant Agarwal, Senior Director & Head, Wealth Advisory Solutions, ASK Wealth Advisors.
"For an investor who lacks the experience of multiple cycles, the simpler, and wiser, strategy is to keep averaging and stay the course," says Sunil Sharma, Chief Investment Officer, Sanctum Wealth Management.
Here are some strategies investors can follow to protect their gains in this market.
1) Rebalance Your Portfolio
This involves keeping allocation to assets at a pre-determined level. This requires constant monitoring of the portfolio as the allocation keeps changing depending upon the performance of the various asset classes.
If you don't rebalance the portfolio, the risk may rise, as the weight of the better performing asset goes up. If you had invested in Sensex and Crisil Composite Index, a debt market performance indicator, in the ratio of 60 per cent and 40 per cent in 2002-end, the equity portion would have gone as high as 88 per cent by 2007-end. When equity markets tanked in 2008, the portfolio would have lost 45 per cent value. However, if the portfolio had been rebalanced annually in the 60-40 ratio, the losses would have been limited to 29 per cent of the portfolio. This is because a part of the earlier gains from equities would have been invested in debt and protected from the downside. The 40 per cent debt component at the start of 2008 would have cushioned the fall.
Rebalancing is about disciplined investing. It may or may not result in better returns but definitely helps in managing risk using the "buy low and sell high" principle.
But there is a small downside too. Nishant Agarwal of Ask says, "Portfolio rebalancing will lead to underperformance during a bull run and outperformance during volatile markets." Here's why. During a bull run, when equity markets are doing well, you will be selling equity and investing in debt. Hence, returns from a portfolio that is rebalanced periodically will be lower than that from an unbalanced portfolio.
Apart from the performance of the asset classes, returns from rebalancing will also depend on asset allocation and investment duration.
But it all comes at a cost. "One should be careful while doing rebalancing as there is a cost attached to it," says Agarwal.
Also, how many times should the portfolio be rebalanced will depend on how actively or passively one manages it. Generally, it is okay to rebalance the portfolio every six months to one year. "One should keep a 5-10 per cent plus-minus window," says Agarwal. This will keep the cost of rebalancing low. Here are some of the costs of rebalancing.
Exit load: This is charged when you sell your equity/debt mutual fund holdings within a certain period. In case of equity funds, the exit load can go up to 3 per cent in the first year. In debt funds, it can go up to 1 per cent.
Short-term capital gains: In case of equity, gains after one year are tax-free, while in case of debt funds, short-term capital gains (less than three years) are taxed as per slab; indexation benefit (adjusting gains with inflation, reducing the tax liability significantly) is available after three years.
Brokerage: If you buy or sell securities such as shares and bonds on exchanges, you will have to pay brokerage as well as securities transaction tax.
2) Nearing goals? Look for safer assets
Just investing for goals is not enough. You also need to preserve and protect the capital when you are nearing your goal. Investors generally focus more on accumulation. They try to do everything right during this phase, right from choosing the best mutual funds to investing systematically. However, if you don't preserve the capital you have accumulated over a period, you might fall short of your targeted amount.
If you are investing for the long term, which means at least five years, experts recommend equities. Remember that even if you are investing through systematic investment plans, or SIPs, in equity mutual funds, the last SIP instalment should get at least three-four years to grow.
However, even if you invest for the long term, what if markets tank when you need money and lose substantial wealth? For example, if somebody invested Rs 1 lakh in 2003, at the end of 2007, he would have accumulated Rs 6 lakh. However, this would have come down to Rs 2.85 lakh by the end of 2008 as the market crashed after the global financial crisis.
As nobody can predict market moves, investors should start transferring money from volatile assets such as equities to less riskier assets such as debt when they are one-two years from their goal. If the money is invested in riskier assets such as mid-cap and small-cap stocks or mutual funds, the process should start even earlier.
Just like putting in money, it is possible to exit investments systematically too. In case of mutual funds, one can opt for systematic transfer plans (STPs) to move money from equity to debt, says experts.
"For long-term goals (over seven years), the ideal way is to go for an STP from equity to debt (liquid and short-term debt funds) over 18-24 months. For those who have not done this and have less than a year left for the goal, moving to low-risk short-term debt instruments such as liquid funds and ultra short-term funds in one go is a prudent option," says Vidya Bala, Head of Mutual Fund Research, Fundsindia.com.
3) Put incremental flows through SIP.
There may be many investors who would be holding on to a lump sum amount wondering if they should invest in equity markets right away or wait for a correction.
Experts say one should not try to time the market. They are advising such investors to invest through SIPs as in a lump sum investment you could end up putting your money at the market's high point. In a SIP, the investments are staggered, and so you keep buying units irrespective of market ups and downs. In fact, as you are putting a fixed amount every month, you buy more units when the market is down, which reduces the average price of units and increases the potential for gains. This can translate into higher returns when the market goes up.
If you have a lump sum, you can either invest through SIP or put money in a liquid fund and transfer it systematically through STP (systematic transfer plan) in an equity fund.
"We have been suggesting that investors use SIP or STP (if they have a lump sum) to invest in equity. For those keen on making good of every market dip, we suggest holding some money, in addition to SIPs, in liquid funds and switching to equity when equity markets fall steeply. However, this is not a substitute for SIPs. It can be in addition to SIPs," says Bala of FundsIndia.com.
SIP No Magic Bullet: Investors should understand that SIP is not a magic formula for making money but a convenient and efficient way of investing in equity markets. SIP investments can also give negative or poor returns if you don't choose the right fund or if you have invested for a short period when the market is not doing well. But if you remain invested for long and have chosen a good fund, you are likely to earn good returns through SIP.
The table, Lump sum Vs SIP, shows how there are periods when five-year lump sum returns are higher than five-year SIP returns. This is more likely to happen if you start the SIP at the start of the bull run and so end up buying units at higher costs. The best time to start a SIP is the start of a bear run, but as it is not possible to predict market lows or highs, experts say that one must invest systematically without worrying about market levels.
4) Reduce allocation to mid-caps and small caps
During market rallies, mid-cap and small-cap stocks outperform their larger counterparts. In the past one year, the S&P BSE Sensex has delivered a return of 18 per cent, while S&P BSE Midcap and S&P Smallcap have delivered 30 per cent and 37 per cent, respectively. But keep in mind that mid-cap and small-cap stocks fall more sharply when markets correct. During the 2008 crash, the Sensex had fallen 52 per cent, while BSE Midcap and Smallcap indices had fallen as much as 67 and 72 per cent, respectively. Therefore, if your portfolio has too much exposure to mid-caps and small-caps, it is high time you trim it, as a correction, if it happens, will hit you hard. "We are advising investors to review their portfolio allocation to cut back their allocation to mid-cap and small-cap stocks," says Manoj Nagpal, CEO, Outlook Asia Capital.
"If an investor is doing SIP in a large-cap fund, we are advising him to keep doing so. But if they are investing in mid-cap and small-cap funds, we are advising them to book a part of the profits," says Tanwir Alam, Founder and CEO, Fincart.
5) Pay off high-cost debt
Loan is always a burden on your finances and most people would prefer to repay it as early as possible. In case you have a high-interest loan that is putting stress on your finances, it is advisable to book some gains to pay off a part of the loan, especially if it is a personal or credit card loan where interest rate can go up to 24-36 per cent. It goes without saying that the chances of earning such returns on an asset are very low. Paying off the loan early not only reduces stress but also results in interest savings. But if the rate of interest on the loan is lower than what you are getting from your investments, and you have little difficulty in paying EMIs, you can continue the investments.
6) Park in accrual funds
The past two years have been particularly good for debt investors as falling interest rates and 10-year benchmark yields ensured double-digit returns. In 2017, the yield on the 10-year paper started hardening after the RBI changed its stance from accommodative to neutral, surprising many. The yields went up from 6.2 per cent in December 2016 to 6.9 in May 2017. Over the past one month, they have again come down to around 6.4 per cent due to low inflation, expectation of normal monsoon and stable rupee even after rate hike by the US Fed. It means markets are looking forward to a rate cut in the coming months.
"If the RBI gets the comfort of consumer inflation remaining in the band of 4-4.25 per cent, it needs to maintain repo rates at 5.50-5.75 per cent levels. This could give it scope to cut rates by 50-75 basis points. In that case, the 10-year benchmark paper can trade in the 6.10-6.25 per cent range," says Murthy Nagarajan, Head, Fixed Income, Tata Asset Management.
However, in spite of yields falling in expectation of a further rate cut, experts are still advising investors to lower expectations from debt funds and invest in accrual funds for lower volatility in returns.
Accrual funds focus on earning returns by investing in high interest rate bonds while duration funds generate returns through capital appreciation by taking exposure to higher maturity papers in a falling interest rate scenario. "People should consider accrual funds to earn steady returns with low volatility. Existing investors can continue to hold dynamic bond funds as a possible rate cut can trigger a rally. For fresh investments, accrual funds are the best, as the possibility of earning high returns through an interest rate rally may be lower this year compared with last year," says Bala of Fundsindia.com.
"Investors who are risk averse but have a holding period of more than three years can look at short-term bond funds. Those with a higher risk appetite can invest 70 per cent in a short-term bond fund and the balance in a dynamic bond fund," says Nagarajan.