When should you book profits?

This post is drawn from a topic posted in the Suggest a Topic page, but the original comment wanted a convincing answer to this question, and I don’t think I have one, but I’ll still attempt to address the question with some thoughts I do have.

First, here is the comment.

I like your articles very much – they are very informative. Keep up the good work!
I have a query – please try to give a convincing answer if possible.
I invest in mutual funds by SIP only and in stocks directly. My SIP in mutual funds are for long periods – ten to fifteen years. I have read a lot on rupee cost averaging and the power of compounding but I am not convinced whether I should let a SIP in a particular MF run for so many years or book profits in between. I review my portfolio every six months. What if the SIP
ran for so many years and finally the MF performance plummets as it happened to
SBI MSFU Contra and Reliance Growth funds? I had been investing in these MFs for the past five years but feel that I should have booked profits earlier.

I touched upon this topic nearly 3 years ago in a post titled Buy and Hold. And Sell?.

If I were to write that post today I would get rid of the question mark. I wrote the following thing in that post:

Don’t forget to sell

Calling a market top is almost impossible, but it is fairly easy to see when markets over-heat. Instead of holding on to stocks perennially, you should sell, when the market is over-heated. There is no reason tonot do this.

When stock prices reach levels that do not justify the earnings of the companies they represent, there is no reason to hold on to the stocks. You should convert your stocks into cash in such times.

From 3 years to now – that conviction has only become stronger – the only thing that surprised me was the speed with which the market turned after the crash. While buying stocks during the ultra depressing time of late 2008 and early 2009 – I used to think that it might take a few years for the situation to get stabilized and earnings will grow then and as a result the stock prices will grow as well.

The turn came much sooner, and then the markets fell this year as well although the fall is not even 20% YTD – all the gloom and doom stories make it sound much worse.

I think when you are sitting on fat profits you should book some of it especially when your postman starts giving you stock advice.

You can take that money to meet major expenses or put some of it in debt instruments to take advantage of high interest rates like you see today, or keep stashing the cash so that you can take advantage of getting in the market when it crashes the next time.

All of these things are much easier said than done, and a lot of it depends on your own conviction and confidence about what you are doing. There is a reason why everyone sells in a panic and buys during euphoria.

You can see this around you now when the Sensex is down almost 20% YTD – how many people are really buying aggressively?

But ultimately, I think you want to be at the place where you are confident in making decisions to book profits, and also increasing your equity holdings during time of distress, and of course knowing the rationale behind it. You don’t want to just buy because there is distress.

I bought equities aggressively in late 2008, early 2009, and that’s what I’m doing right now. Not everyone will think it’s the right thing to do because of their confidence in the market, need for cash in the near future, or even opportunities and I can certainly understand that.

Those are my thoughts, I don’t for a minute think they are “convincing” because I think it’s one of those things that is a lot harder to do than to talk about – if it weren’t – everyone would be doing it.

11 thoughts on “When should you book profits?”

  1. Manshu,
    Thanks for the detailed reply. Also, what you said about long term investment has not crossed my mind. I picked up stock when they went below their recent issue price (e.g. Tatasteel and MOIL). Both of them continue to go down. The CMD of MOIL says that their business is linked to steel. I will wait and watch on them. I will think about booking profits when I really sit on huge profit.
    It looks like a good time to buy large caps now. Which ones, I guess, is ones own decision to make 🙂
    keep writing.
    Right now FD doesn’t seem so bad and neither does PPF.

  2. Manshu and others,
    Nice post and useful comments. I am a recent investor into equity (starting 2010). I saw some of my stock loosing ground over the past 6 months. However, they are large cap players and have invested mainly in large cap with a long term focus. As Manshu mentioned, there is this desire to buy more of the stock I lost money in to average out (e.g. Tatasteel). I feel the company has a good long term growth, given the fact that steel can’t be ignored as a commodity. An interesting comment by Manshu is when to sell to book profits. I haven’t thought about it, as I want to be invested in equity long term (10-20 years). At present I have surplus of cash and have divided equally between equity and FD. I will continue to have this surplus, barring emergencies. But, I want to know or seek wisdom on how much exposure is necessary for a salaried employee in PB4 with NPS, government medical/housing for next 31 years. One thing I learnt about indian markets is that there are too many punters who make money and FIIs run the rally either way (meaning I am not too concerned with daily ups and downs in the market). Sometimes, the fundamentals of the company are thrown to dogs. Any comments on long term investment in large cap and PSUs would be appreciated.

    1. Krishna,

      Your approach quite resonates with my own, and it just so happens that Tata Steel was one stock that I used to own in the past. Now, here’s the thing that I’d add to what you laid out – one is that even with large cap stocks you don’t know what could go wrong and when they lose favor. With Tata, at least till a few years ago the concern was their huge debt and how Corus will perform, and with every other company it will be something else. And large caps do lose favor when their growth starts to slow down like HLL used to be the bluest of blue chips but has languished in the past few years. In 90’s ACC used to be this kind of stock.

      The point I’m trying to drive home is that while the chances of something like Tata Steel which is more than a 100 years old going down are very low, it’s not unthinkable that the stock price languishes for a few years. That’s why you need to hone in on a bunch of such large caps and have them in your portfolio.

      And for profits – I think you haven’t thought about selling because you haven’t had an opportunity to sit on huge profits yet. When that happens, and when you know about the volatility and long periods of minimal returns of of the market – for instance I just looked up 5 year returns for Nifty and in the last 5 years Nifty returned 22% – so potentially you could be in a situation where you are in a 100% profit and then boom 5 years later that’s just 22%.

      In my opinion when you see euphoria in the market, and when you have been smart enough to buy during panics you should book some profits and get rid of some mistakes.

      This is a journey that everyone has to make and figure out what works for them and what doesn’t. I don’t pay any attention to technical analysis at all because I feel that it doesn’t work for me but I don’t think that it doesn’t work for anyone. There are people who have been traders for 10 years or so and I guess they must have made money to stick to it for so long. So there are several ways to make this thing work and you have to find what works for you and refine that.

      Does this make much sense to you?

  3. Ashok, you have said rightly. We don’t allow people to drive car without taking a driving test or a license but allow people to enter complex financial world without any financial background/education. That is where forums such as onemint helps.
    You are not alone..most of us have burnt their fingers in 2008 downturn. I personally also followed the Dividend payout approach but a negative side to it is that the purpose of investing in equity gets defeated. When you redeem you get almost the same amount that you had invested and the dividend sits in bank account..
    In DTC the dividend would be taxed. So you might need to change your approach. Onemint has discussed it sometime back Equity mutual fund dividends will be taxed under the Direct Tax Code by MANSHU on JULY 13, 2011

  4. A very good question and a good answer.
    I have been investing in Equities and Equity MFs for 8 years now and I simply don’t know the answer. You learn by your own experiences. After burning my fingers in the 2008 downturn, I sold off most of my equity portfolio in the run-up of 2009. These days I don’t invest in direct equity at all. But it still pains when fundamentally good large-cap stocks like ICICI Bank or RIL or NTPC fall 20-30%. Then the regretful feeling of “what-could’ve-been-done” lingers.

    I have started a new strategy with my Equity MFs recently. All large-cap funds in Growth mode, and small/Midcap funds in Dividend Payout mode (all investments in SIP only). This way if there is a run-up in the markets, some profit booking is done (by way of dividends).

    1. I think everyone has to figure this out for themselves, I see several people writing in to say that they have lost faith in the market because their stock lost 80%. Well, in that case you should have lost case in your ability to pick stocks – not in the market!

      People have to take more responsibility, understand what works for them, and then act accordingly.

  5. A very apt question I must say. We all are so worked up in making an investment that we do not spend much time and effort in finding when to exit.

    Always start with an end in mind we are told. But how often do we make an investment using this approach. These days the rules of investing have changed(our parents approach of investing in guaranteed returns is not enough) and market is so volatile that anyone does not know what will happen tomorrow or a month from now or 10 years down the lane. Days of making an investment even in MF’s and then forgetting it till you need some 10-15 years down the lane seem to be over.

    Coming to specific MFs such as SBI Contra and Reliance Growth which were the most preferred MFs few years earlier are now not doing well. Valueresearchonline has repeatedly asked investors to withdraw from these funds as they have been under-performing their respective Benchmarks.
    An interesting article on valueresearchonline.com hope it helps When to sell

    Bottom line is : It is your money and you alone can decide whether to withdraw or not? Take the bigger picture in mind..and maybe set a stop less.

    1. You know what – if you make the end to own a stock forever – your whole perspective will change. Yes, not 2 years, not 5 years, not 10 years, but if you say I’ll never sell this. That’s probably next to impossible for most people to think about (including me) but when you start thinking about stocks in that manner – it brings in a profound change in the way you approach individual companies. You will never touch penny stocks, and gravitate towards companies that have been in existence for long, very long like 100 years long, and that in itself saves you from a lot of heartache that people get because of entering penny stocks and other substandard companies.

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