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When is the best time to exit the equity market?
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Nobody can time the market. You need to decide what returns you want, over what period of time and, accordingly, enter and exit the equity market
It would be quite wrong to assume that everyone is investing in equities these days. Those that bought in 2008 and were subsequently disillusioned, are selling. They think they have waited for a long time. Now that there is some sign of profit or even of a break-even, they want to quit. Then there are those who entered the market in recent times. They did not expect such a run-up so soon. They see the frenzy and are worried. They do not want to make the mistake of not booking out in time.
The real question, therefore, is not about buying. It is about selling.
When equity markets turn around and begin to run up, there are at least three things to consider. First, the markets will remain unpredictable. That is their nature, and even if everyone is convinced that the next big bull run is here, the markets may not always oblige the bulls. Second, no one knows the top of a bull market. A market that runs up is not defined by how far it can go, but by how much it can fall. So, there is no point in asking if the number to look for is 30,000 or 50,000. We simply do not know, and it actually does not matter.
Third, what worked in the past, will not work in the future. So trying to quit the market at every turn is like asking if you should get off the train at every station that it happens to stop.
Equity investing does not lend itself to simplistic theories and rules, much as we crave for it. Therefore, rules that ask for `profit-booking' as soon as the money has doubled, or after a target has been achieved, or when a magic number has arrived, may all prove to be wrong.
In the best case scenario, the investor can get lucky . In the worst case scenario, the investor may miss a large part of the bull run that happens after he exits. Imagine an investor coming into the markets in 2003, at a Sensex level of 3,200, after the technology boom and bust, and feeling very wary and cautious. Then, imagine him quitting after a 20% return at 3,800 levels. Or, quitting after the index doubled to 6,400. When the index scaled 20,000 this investor would be quite sorry , even if he did not admit to his tactic having gone horribly wrong. So setting up a strategy to quit based on assumptions about how the market will behave in the future can go very wrong. Then the investors worry about getting greedy . Coming out of a bear market, the predominant thought is caution.
Investors recall how they failed to get out at 20,000 and paid heavily for it. They tell themselves that markets are unpredictable, so the best thing to do is book profits. So, they ask of market experts to not exhort everyone to simply buy , but also indicate when to sell. But such advice is not easily available. Apart from business considerations of market players, whose money depends on the investor staying rather than leaving, there is this inherent unpredictability of the markets that can make such recommendations so completely ridiculous. Which expert would stake his credibility to call the top and watch the markets soar even higher. So, investing by hanging on to someone else's coattail also does not work. Even if that someone is an expert.
So what should one do? An investor, who is booking profits, is actually taking money out of equity and putting it into his bank. This is an asset allocation decision. Each time money is moved in and out of equity markets, the investor is not `booking profits' but rebalancing his money . The moment we convert the problem into one that focuses on the investor, rather than the market, the solutions are actually simple. Investors can deal with how much money they need to have in equity based on what returns they need, what risks they can take, and how long they can wait. Therefore, an investor who plans to fund his child's education coming up in the next 15 years, will need a higher proportion of his money in equities so that he beats the inflation in education costs. Let's assume that this investor holds a portfolio with 60% in equities and 40% in debt. This allocation is called the strategic allocation, and is the most critical decision any investor can make. Irrespective of where the market is, this investor needs 60% of his money to be in equities.
When equity markets appreciate, they take this proportion up. Higher equity allocation means higher return and higher risk. Therefore, the investor can do a `profit-booking' to bring his proportion back to 60%. He need not do it every day, but a half-yearly review or even an annual rejig should be fine. Not only does he know how much to `book', but also does not care where the market is when he does that. This kind of devil may-care rule takes out the noise, emotion and confusion from investing and helps immensely . In a market that moves in cycles and remains largely unpredictable, actions that are based on the wisdom that things will average out eventually, work their zen-like magic.
Those that cannot tear themselves away from `taking a call' should train their eyes on how much the market can fall. That is more important than how much it can rise. This upside potential versus downside risk assessment is the tactical approach to dealing with the question of profit booking. From asking what is the market PE. Seeing if the prices are above or below the 200-day moving average. Asking if there are too many IPOs at high prices. And, seeing whether every one and his uncle is bullish. The tactical approach means looking for signs of crack up. It may not result in liquidating equity positions, but bringing them down significantly . Investors may not always get it right, nor would they manage to quit right at the top, but may get a higher sense of control. We know the top only after the event, so there is no point trying to guess it -unless we bet on getting lucky
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