Active investors face two key questions while monitoring their portfolios: What should I buy? And, what should I sell? When the markets are red hot as they are now, these questions are relatively easy to answer.
Buying in the current market is purely for momentum seekers with a short-term view. Even short-term trading can be penalised by trending markets, such as the ones we saw in the last week. The key difference between a long-term investor and a short-term trader is their focal point in decision-making. For the long-term investor, it is the rate of return that matters the most. Such investors are willing to suffer short-term losses to the invested capital in order to earn long-term gains. To the short-term trader, it is the optimisation of capital that matters most; such investors are willing to suffer negative returns and book losses to recoup and redeploy capital.
The current market favours the latter, because at higher prices, the probability of earning a higher return can only decrease. Except for stocks that deliver a large earning surprise in the coming season, there may be limited scope to buy for the long term. Therefore, there’s little point in searching for the ever-elusive buy list. More importantly, it will take a lot of grit to keep off the highly priced stocks, IPOs and new names in mutual fund lists claiming to be doing better than the veterans.
Selling is a relatively simpler decision, since you can only sell what you are already holding! Behavioural scientists have shown that investors love to sell winning stocks and funds and tend to hold on to losers. Rising markets create an immense temptation to sell off winning stocks and funds and feel smug about the profits. That should be the last thing on your list. Instead focus on the laggards, using a strong will. When the tide is up and everything seems to be rising, if there are funds and stocks that are still lagging behind, they have to be sold off. IPOs bought with the intent to sell, but then re-classified as ‘long-term’ since they listed lower, are prime candidates. Sweep with a long broom and sell the junk for whatever you can get, since you may not get a better price. Closed-end mutual funds, bought during the NFO frenzy of 2006 and 2007 would now be free from the three-year exit load. If they are underperforming their peers, simply sell. It is okay if there is a loss. It is also okay if the capital loss is long term and cannot be set off, but this opportunity to spring clean may not come too often.
If you hold too many stocks and funds, it may be a good idea to consolidate. Even if you bought the best multi-bagger of a stock or hold a fund that has given a 25% compounded return, the key question is how much of your portfolio is in this winner? If you hold too many stocks and funds in your portfolio, the ability of any one of them to make a difference to your portfolio return is small. Strengthen the portfolio by reducing the number of holdings. A mutual fund is already diversified, so consolidating and holding a large chunk in 10-12 funds in all may be a good idea, rather than holding a portfolio of 50-odd funds and 100-odd stocks with varying levels of performance.
Then there is the question of what to do with the money that is lying in the bank and was not deployed in the markets. In the desire to invest at the right time, this money remained un-deployed and the market now looks too high. If and when the correction comes, there will be panic and the courage to invest may not recur. Apply a simple rule: How much is the cash compared to your current wealth? If it is more than 50% of your wealth you have been too conservative and cannot take the risk of investing the money now. If it is only 20% or lower, it is not too high to create a problem. So go ahead and deploy it in stocks, gold, bonds and funds just as you would have normally done. We brush, bathe and eat irrespective of the news headlines. And we can invest and be happy irrespective of the market level.
The writer is managing director, Centre for Investment Education and Learning. Views expressed are her own
