Financial risk, reward, goal: Here's the right way to book profit

Don't try to excessively time the market or exit an investment because others have done so, say experts

With stock markets at a new high, investors want to book profits ahead of the New Year. Worries about Covid-19 or US markets moving down slightly could be factors too, but it's important to book profit correctly. "Deciding when to book profits depends on various factors, including your investment goals, risk tolerance, market conditions, and the specific asset you're holding," says Vijay Kuppa, chief executive officer (CEO) of InCred Money.

Achieving goals

A major reason for booking profits is when you have achieved your financial goals. "If one is near a financial goal or if the allocation has gone beyond the comfort zone, one should look at the existing mutual fund," says Mrin Agarwal, founder and director, Finsafe India.

Optimal profit booking is recommended when approaching your financial targets. "Mitigate the impact of short-term volatility on your investments by transitioning gradually into high-quality debt or deposits, especially when approximately 2 years remain before reaching the designated investment goal, " says Jay Thacker, member, Association of Registered Investment Advisors (ARIA).

Always keep market conditions in mind. "'Be greedy when others are fearful and fearful when others are greedy’ — this quote from Warren Buffett is a good guidepost. When equities are overly hyped and valuations seem stretched, considering profit booking may be wise," Kuppa says.

For rebalancing

Profit booking is advisable through re-balancing when equity holdings surpass the targeted asset allocation, typically by 5-10 per cent in the portfolio. "If it is rebalancing, exit small allocations, the ones with the largest variation from allocation. Once rebalanced, strictly deploy in other asset classes. Rebalance once a year, either at calendar year-end or FY year-end. Keep a good buffer of 15-20 percent on the deviation from allocation," says Agarwal. 

Markets are volatile, so do not book all profits at once. Instead, you can phase your profit booking based on a schedule or by way of a systematic withdrawal plan (SWP). This strategy will help you book profits without needing to time the markets. "This can be useful in two ways: It can help you in tax harvesting, and you can plan the use of this withdrawal in some other asset or to reduce your liabilities. Furthermore, just in case a swift recovery leaves you feeling regretful,” says Jinal Mehta, a certified financial planner and founder of Beyond Learning Finance.

It may be a good idea to optimise for taxation so that your tax outflows are reduced. Kuppa says, "If you are making substantial profits in a few scrips, you may want to book some losses in others to offset the gains and reduce the liability. It is important to note that both the profits and losses should be either long-term or short-term to be set off."

Valuation and gains

When booking profits, resist the allure of predetermined target prices (e.g., RIL – 3000, SBI – 1000) or percentage gains (say, 100–150 per cent). It can be difficult to decide what stock to hold and what to sell as an equity seller. Some investors sell positions with big gains and others suggest taking money off the table after hitting a return target, say 25 per cent. Thacker says, "Instead, focus on valuations, especially forward-looking metrics (e.g., PEG). In the face of a sector or broader market entering a cyclical bear market, thoughtful exit planning is essential." Decisions should be based on a thorough factor analysis, particularly when valuations persistently exceed historical averages.

Avoid a hardline approach of all or nothing when booking profits, especially if there are no imminent short-term financial goals. "In overvalued bull markets, consider retaining substantial portions of your investments and making tactical decisions. Predicting market highs and lows with precision is challenging, so staying invested in alignment with your financial plan and maintaining proper asset allocation is crucial for achieving your goals," Thacker says.

There's an exception. Kuppa says, "If the stock you are holding is a dud and does not have good fundamental prospects, it is better to sell it completely if a favorable opportunity arises." If a fund is likely to continue underperforming, it is better to exit and switch.

One common mistake is the lack of a redeployment plan. Thacker says, "Funds redeemed and left idle in bank accounts depreciate in real terms. Always have a well-planned redeployment strategy in place, identifying suitable avenues such as high-quality debt or bank deposits." Alternatively, consider contributing towards your financial goals in advance, especially if it comes with discount benefits.

It shouldn’t be that you have booked your profits and reinvested in the riskier product. "This is mostly because of the overconfidence bias that investors face. This may not pan out well if the market surprises you with a bear move," says Mehta.

Advice

For both mutual funds and stocks, adhere to prudent investment practices. Begin by establishing a proper asset allocation that aligns with your goals, risk tolerance, and financial situation. Thacker says, "Regularly monitor investments and stay informed about market trends for tactical decision-making. As you approach your financial objectives, adopt a phased redemption strategy to gradually fulfill your aspirations."

Being disciplined and having a well-thought-out investing plan will minimise regrets. Kuppa says, "Avoid attempting to excessively time the market."

Keep tax harvesting in mind before you take any dramatic profit booking. Mehta says, "Also, don’t book profit just because you want to follow the trend and exit because others have done so."

Investment goals

Tax-loss harvesting is a method to offset the gains from sale of stocks or redemption of mutual funds against the capital loss, and pay Income Tax on the net gains

Long-term capital losses can be set-off against only long-term capital gains. You cannot set-off long-term capital losses against short-term capital gains

Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains