EXITING YOUR EQUITY PORTFOLIO ? DO IT FOR THE RIGHT REASONS.

After the volatile experience last year, the equity markets have considerably recovered as on the eve of the new year. A lot of investors would be seeing attractive returns on their equity portfolios. Some of you may be even wondering whether should you partly exit your equity portfolio, switch to debt or book profits. While it may be entirely misplaced to think like this, you should do it for the right reason. Unfortunately for many, redemption is an emotional decision and not a purely rational one.

In this write-up, we will explore the various aspects of exiting equity and the right reasons to do so. Here are the justified reasons why one may exit from equity.

PORTFOLIO RE-BALANCING

No one can predict the markets and accurately timing markets is impossible. However, practicing the strategy of asset allocation is the best and the closest we can get to it. There are two broad ways in which asset allocation strategy can be followed as given below.

1. Fixed Asset Allocation:

where the proportion between equity and debt is fixed

2. Dynamic Asset Allocation:

where the proportion between equity and debt is dynamic within a range decided as per market situation /valuation.

The portfolio re-balancing would mean that you balance the portfolio by shifting the assets which have increased in value to assets with a lower value. As equity markets outperform, one would thus exit equity, but the total portfolio value would remain intact. The portion of debt would always come in handy when equity markets see a sharp fall. Over time, the asset allocation strategy will give you superior returns as you are taking advantage of both the asset classes. Needless to say, this is the best approach /strategy we recommend managing a portfolio.

FINANCIAL OBJECTIVE / GOAL MATURITY

It has been said that money is nothing but the means to an end. The best way to make use of money would be to use to fulfill your life goals and financial objectives. Your asset allocation will be dictated by your goal horizon and your required target amount. The longer the investment horizon and the higher the requirement of returns, the larger will be the proportion of equity in your portfolio. Ideally, equity should only be a part of your portfolio if the goal maturity is over 5 years.

As the goal approaches near, you may start shifting from equity to debt to avoid any last-minute volatility in equity at the time of goal maturity. Exiting from your portfolio at goal maturity was the purpose of investment.

TAX-LOSS HARVESTING

This is a sort of temporary exit only to re-enter when the purpose is served. Investing in equity funds one makes capital gains which are taxable depending on how long you have stayed invested. Tax-loss harvesting is used to reduce tax liability on investments. At the end of the day, your portfolio continues to stay intact however only the notional capital gains changes.

In tax-loss harvesting, one would sell your stocks/fund units at a loss to reduce your tax liability on capital gains. It is a method to offset the capital gains made on equity against the capital loss suffered to pay a lesser amount of tax. It is also used to book profits when they are small and re-enter at a higher price to reduce capital gains. Please note that implementing tax-loss harvesting as a strategy requires some sort of expertise and is not recommended for everyone. One should consult your distributor or your tax expert on the need for the same and how best to do so.

CHANGE IN THE RISK PROFILE

A person’s risk profile should dictate the asset allocation he should follow. Over time, the risk profile changes according to your appetite, knowledge and financial situation. It would also change when there is an important life event. Changing your exposure to equity to match your risk profile may require exit from equity. However, here too, your portfolio value should stay intact.

BOOKING PROFITS

Many investors redeem their investments without any clear plan or reason. Just redeeming your portfolio and taking cash home because you have seen attractive returns is not a sensible reason to exit from equity. One reason why this is a stupid thing to do is that you are exiting from growth assets which are likely to compound for many years. Real wealth would be created only when these assets are allowed to grow and compound for many years.

Imagine yourself buying a share like Wipro or Reliance Industries a couple of decades back. Would you consider yourself wise if you booked profits when the share prices doubled?

Such shares are worth over a hundred times more than the original investment. You get the point.

SWITCH OUT OF NON-PERFORMING SCHEMES / STOCKS

Diversifying or re-balancing your portfolio into performing funds or stocks is another common reason why people sell. However, we do not really know if the new choices will always work for us. It has been seen that people who shift their portfolio to the top-performing funds every year, will likely have a below-average performing portfolio. Thus, this may not be a wise strategy to follow, especially in the case of mutual funds. It is always better to stick to funds for the longer horizon and give them time to perform.

PANIC DUE TO MARKET CRASH

This is again a very common phenomenon where investors panic and book the notional losses on their portfolio in fear of further falls. Obviously, nothing can be worse than booking losses when potentially the markets are at their best for new /fresh investments.

UNEXPECTED FINANCIAL CRISIS / NEED

While a financial goal is pre-planned, one can be faced with an emergency. Redeeming your portfolio would be wise in such a case. However, we would recommend sitting down with your distributor and appropriately decide which asset class and funds to liquidate instead of randomly exiting the portfolio. Further, you may even explore Loan Against Securities (LAS) in case you need funds.

LOVE FOR CASH HOLDING

Nothing can beat the pleasure of having cash in hand /bank.

There is no denying that gives us a sense of mental comfort. We are sure that the value of money in the bank will not depreciate soon and will not fluctuate. Many people redeem a part of their portfolio to enjoy this comfort. Not a valid excuse, but then it is your money at the end of the day. What we would recommend here is that have an emergency fund ready equal to say 3 to 6 months of all your expenses in cash or liquid funds.

Do not let excessive cash sit idle for long periods as you would miss out on the fun happening in the markets.