One of the most difficult questions faced by investors in the equity markets is "When should I sell my stock or mutual fund?" I have come across investors who are often advised to buy and sell, hence churning their portfolio under the name of Active Portfolio Management.
I have also heard investors say that they are continuously bombarded with buy messages but rarely do they hear the sell message. For every 10 buy recommendations that are given out, there is one sell recommendation. Just watch the broker recommendations on business channels for an hour and you will know what I am trying to say.
Ask yourself: "How do you decide when it is time to sell". Pause for a moment and reflect on this question. So the point really is, when should you sell your investments? Generally there are seven situations when you should SELL:
1. When you need the money for a goal or need
You have been saving for buying a house, taking a vacation or for your child's education. These are tangible goals for which you need money. At least 6-12 months before you need money for a goal sell your equity investments and move the funds into a fixed deposit or floating rate fund.
If the market is down at this point of time, see if you can utilise any other source of funds for your goal and check whether you can wait for an additional period of time. This decision on whether to ride the downturn a few months before you need money is completely based on your risk tolerance and varies for different people.
2. You need money for a personal emergency
There might be a time when a personal emergency warrants far more money than you have as contingency funds. At such times when bonds, PPF and post office instruments might have a lock-in, you can look at selling your worst performing investment.
3. Your investment has gone sour
There are periods where your investment will under perform the broader market. Should you immediately sell at this point? We generally give any fund manager a couple of quarters of underperformance especially if he has a consistent track record of delivering risk-adjusted returns.
Check out the reason for underperformance whether it's due to high concentration to few sectors, or a fund manager change or bad market timing etc. Generally when a fund does too well, there is a lot of money that flows into it and hence you might see some underperformance in the funds performance due to excess cash in its portfolio.
In terms of a direct stock investment check whether the reasons for which you invested in a particular stock are still valid whether it be an excellent management team, earnings growth, innovation. If you still believe in the company or fund manager, then you can also look at making additional investments in the stock or mutual fund.
4. Your return expectation is met or exceeded
Some people set targets such as a return of 15 or 20 per cent and then exit whenever this target is achieved. What do you then do after selling the investment? Generally you wait for a dip but what if the economy is on a roll like the one we have where the index has been going up either due to excess liquidity or market fundamentals.
Several people who achieved their 30 per cent target and moved out of the market at 9000 are still waiting to re-enter. Market spurts and downturns happen in very short periods of time. We have all witnessed the 1000-point downfall in May in one day and similarly consistent 400 point moves couple of times in a week.
5. When you believe the Market is overvalued and that a Correction is imminent
This is one of the most difficult reasons to execute and get right. This assumes that one can easily time the market knowing the very top and bottom. Though all would like to believe this is possible, in the real world nothing could be further from the truth. The biggest frustration that investors and investment advisors have is when they sell and the market goes up another 20 per cent.
Does this make it a bad decision? There is no definite answer and hence is situation specific varying from investor to investor. Don't judge yourself on the basis of this decision; it could have gone the other way as well. By the way it is better to sell an overvalued stock than to buy one.
6. When you need to rebalance your portfolio
Asset Allocation is one of the key decisions that any investor must make in his lifetime and studies have proved that asset allocation accounts for almost 91 per cent of your investment performance. Suppose you decide on an equity exposure of 60 per cent and 40 per cent debt, but because of the bullish market conditions, your equity exposure has gone up to 80 per cent, then to bring back the portfolio to its original allocation, you would need to sell Equity and buy Debt.
7. When there is a better opportunity available
This last reason is normally one of the most frequent ones and results in churning investor's portfolio. Webster defines churning as "To make (the account of a client) excessively active by frequent purchases and sales primarily in order to generate commissions".
As given above if you feel that your investment has gone sour you should dump your investment and look out for better options else just stay put. Like elsewhere, Fidelity pays in the Investing World too as you lower your costs and taxes and maximise returns.
Now that you have a control on when you should sell your investments, consider the costs and tax implications before you actually sell. However, if you have a winner in your portfolio, then as Warren Buffett said "Our favourite holding period is FOREVER."
The author is a practising Certified Financial Planner. He can be reached at amar.pandit@moneycontrol.com
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