Myth of Profit Booking
During our interaction with our clients, one query –in different words but with same intent—invariably pops up “why don’t you book profits every now & then?
The logic (?) of profit booking is:-
Investor needs a feel of the money he’s making
Markets may
tank suddenly wiping out his portfolio gains.
Profit
booking reduces the risk of exposure to the market.
Et all
Profit booking involves reduction in unit holdings. So, when the bullish trends re-appear in the stock market; you make less gains as your unit holdings have reduced owing to profit booking.
Let’s explain this by an example.
There are 2 investors holding say, DSP Small cap Fund.
Who won by booking profit? It’s for you to see.
Profit booking assumes price movement at a future point in time, in favour of investor. This is hardly the case in real life. Retail investors in their zeal to encash at the top (perceived), usually ends up buy high sell low. It (profit booking) is precisely because of this reason that FIIs control roughly 25-30% of our market.
Fund Underperformance more often than not leads to nervous investors exiting the fund in a hurry.
Fund performance over a period of time goes through phases of over performance, stagnant, and under performance.
Even if one picks a fund that would beat the index over the next 15-20 years, it will go through periods of underperformance. When a fund starts underperforming, we never know if it will recover, beat the index, or continue underperforming. The fund manager may be unable to protect his job before his fund recovers. The legendary fund manager of HDFC MF—Prashant Jain—confessed in an interview in 2020 that he was on the verge of losing his job due to his funds underperforming. But luckily his funds recovered just in time and he got to keep his job.
Many investors— aided and advised by their advisors—and advisors exit an underperforming fund and shift to a fund that is currently the best performing fund. This strategy sounds logical, but it guarantees under performance. You enter a fund when it has already performed well, stay in it until it underperforms, exit it to invest in a better performing fund—and the shift in and shift out continues. You are taking underperformance from every fund that you are investing in. and then you blame the market. Frequent exit & entries of funds also incur a tax liability, which further reduces not only your return but also the probability of beating the index.
We believe that the issue of out performance or rather under performance should worry investors in mature markets like USA, UK etc. India is a growing economy and this growth and out performance is expected to continue at least for the next 30-40 years.
So, the market will reward you handsomely for simply sitting on your investments. This is aptly put as
"It is never your thinking that makes big money,
it is sitting."
So, rather than spend sleepless night thinking about profit booking, aim for wealth creation and put up a Do Not Disturb board around your portfolio.
