When it comes to investing in the stock markets, one advice that is universally doled out is to book profits. Direct stocks – yes! Traders – definitely yes!
But does it apply to mutual funds too?
There is quite a difference in the two.
With direct stocks, there can be multiple reasons for you to book profits.
Let’s be clear that you invest in a business via a stock market purchase and then you become entitled to its profits and losses. You should hold the stock of a good business forever, as famous stock market gurus would tell you.
Yet, there are reasons to sell or book profits. Let’s consider some of them. #1 You believe that the stock that you bought has gone beyond its real value (or intrinsic value). It is best to book profits now and may be reinvest in that stock later.
#2 You find a better business, the stock of which is far more attractive and you would like to shift your investment.
#3 You simply feel that based on your new analysis of the business, it is not as attractive as it originally appeared to be and it is best to exit or cut down allocation.
#4 You need the money for a real cash flow need such as a medical emergency, paying for your child’s higher education or may be to make a downpayment for your house.
Now these are real reasons to exit or book profits on a stock.
What about mutual funds?
Prima facie, investing in mutual funds is an outsourcing decision. You ask someone, a professional investment manager, to manage investments on your behalf.
This professional investment manger does all the analysis of finding businesses that would make sense in a portfolio and he watches them on a regular basis. He applies the same guidelines as mentioned before (except #4) in keeping or selling the stock.
So, the only big reason for you to sell or book profits in your mutual funds is when you have a real need for money to meet one of your financial goals.
But you see, this is not an ideal world.
There are 2 more reasons to book profits in mutual funds.
#1 Something fundamental has changed about your fund – its mandate or its philosophy, which is not in line with your initial assessment. For example, a mid cap fund starts behaving like a multi cap fund. Or, a fund substantially increases its expense ratio. Or, there could be no one in command of the fund management ship – who’s managing the show?
Each of these could be a compelling reason to sell / switch / book profits in a fund.
#2 When you invest, you divide your investments into multiple baskets to achieve diversification. You allocate weights to various asset classes (equity, debt, cash). You do an asset allocation. As the various assets grow or don’t grow, you evaluate them periodically and shift your money from one to another. This is called rebalancing.
Suppose your equity allocation has moved up from 50% (original) to 70% (now). You need to ensure that you rebalance it to bring it back to the original allocation. So you sell some of the investments in equity (upto 20% of the portfolio value) and shift them to other assets such as debt. Job done.
Hopefully, you realise that in mutual funds, the business analysis, stock valuations, etc are already being taken care of by the fund managers. Based on their assessment, they also book profits as and when required. You need not duplicate the process at your end.
Keep a check on your fund selection parameters and your asset allocation. These are the 2 things you truly need to be concerned about.
What do you think about profit booking in mutual funds? Do let us know in the comments.
Great article. May be another reason could be when your fund start loosing its rating.
Well, that drop in ratings can be a reason to have a check on the fund and not get rid of it. There are several examples where the fund rankings fail to capture a good fund. One of the largest rating agencies itself points out that rating/ranking by itself should not be used to decide to buy or sell a fund.