The stock markets are hitting new highs and investors must be facing the common dilemma – whether to book profits and then re-enter the markets on correction. When that correction would happen, no one knows. Predicting It would be more difficult than winning Blackjack in a casino. Although markets are cyclical and they reflect sentiment based on potential political events, macro-economic indicators, corporate earnings performance, it does not mean an investor can accurately predict the entry and exit of the markets. Not to forget the fact that markets tend to overreact many times, mostly during the corrections. One can get lucky at times but not consistently lucky. Trying to catch the peaks and bottoms of the market can be thus dangerous.
So, how does an investor deal with this predicament of when to buy and when to sell. The best thing to do is not try to time the markets at all. Instead of timing the market, here is what an investor can do:
Regularly invest in a disciplined manner: The very reason investors find themselves in a quandary of entering and exiting the markets is because they have not addressed the most fundamental issue. The purpose of investing. When an investor defines his goal, his purpose and aligns it with his investment horizon, the answer is easy to come by. When an investor clearly knows why he requires the money and when does he need it, his primary aim is then focused on meeting his financial goal rather than scouting for opportune moments to invest. A systematic investment plan in a mutual fund is the best way to stagger investments, spread the risks and average out the cost over a time period. The best thing about SIP investment is that it happens on a pre-determined date which is neither governed by fear nor greed.
Rebalance the portfolio: Majority of the investors do not view their portfolio in totality. They evaluate the performance of each asset class on a piecemeal basis. However, just like every organ in a human body serves a unique purpose and if harm to any part affects the overall system, so is the case with an investment portfolio. The presence of each asset class, be it debt, equity, gold, etc is relevant in a portfolio and in the proportion depending upon an individual’s financial goals and his risk appetite. While equities provide growth to a portfolio to beat inflation, the debt component (fixed income) lends stability and safety in the scenario of falling stock markets. Too much exposure to any one asset class can affect the performance of the total portfolio. It is thus important to rebalance the portfolio as markets fluctuate and valuations change.
For instance, assume an investor has a portfolio with 60 per cent equity and 40 per cent debt. Now, suppose with rise in markets, his equity component in the portfolio went up to 65 per cent and the debt part reduced to 35 per cent. Here, he should book profits and park the profit portion in debt to bring the allocation to the original 60:40 ratio. This is called rebalancing the portfolio and needs a periodic review. Rebalancing helps to tide over volatility in the markets. If an investor stays invested out of greed and tries to time the market expecting new peaks, he would be exposed to higher risks of downfall and huge erosion in his portfolio value.
Redeem when goals are near: Suppose an investor has started SIP for his child’s education few years back and would require money after 3 years. The markets are in a bull run. Timing the market here and waiting for new peaks could be dangerous. What if the markets nosedive tomorrow and take a long time to recover? The investor could fall short of the actual corpus needed at the time of funding the education goal. Instead of timing the market, an investor thus needs to gradually shift from equity to debt and reduce his risk as his goal is nearing.
To conclude, no crystal ball, no stock market expert can predict the stock markets, leave alone an average investor. It is thus futile to chase the peaks and troughs of the markets. Invest in a disciplined manner regularly and redeem only when your goals are nearing or when rebalancing the portfolio. Let your money compound and grow over the longer run. That is the sure shot way to riches.