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Friday, May 12, 2017

The stock market is at a lifetime high - should you buy, sell or hold?

A TV anchor was interviewing a fund manager when the market started to correct after touching a new high. The following is a brief excerpt of the Q&A session:

Q: You are holding 16% in cash. Is it because you are expecting a big correction in the market?

A: It's not like that. We hold a basket of stocks and have price targets for each stock. When a target is hit, we book profits.

Q: You mean several stocks have hit their targets during the recent rally - that is why you have excess cash? Why are you not redeploying in other stocks?

A: It is difficult to find new ideas near a market top, as everything appears overvalued. So, we have invested in money market instruments.

This is a classic problem that fund managers face. They can't afford to hold large amounts of cash because it affects fund performance. But they are wary of redeploying at high valuations in case the market turns against them.

Small investors with a long-term outlook need not be bothered by such a problem - provided they have a proper asset allocation plan.

The asset allocation plan will determine the investment strategy. How?

Let us look at an example - a plan with 70% in equity shares, 25% in fixed income instruments and 5% in cash. That means, out of a monthly saving of Rs 10000, Rs 7000 is being invested in an equity fund, Rs 2500 in a debt fund and Rs 500 in a liquid fund.

After a year, the invested amounts are Rs 84000 in the equity fund, Rs 30000 in the debt fund and Rs 6000 in the liquid fund

Due to the bull rally, the NAV of the equity fund has gone up 20% - so the amount in the equity fund has increased to Rs 100800. The amount in the debt fund has increased to Rs 31500 (say), and the amount in the liquid fund is Rs 6500.

The asset allocation has now changed (due to the rally) to 73% in equity fund, 22.5% in debt fund and 4.5% in liquid fund.

You now have three options: 
(i) book partial profits in equity fund and redeploy in debt and liquid funds to restore the original allocation and continue with your monthly SIPs; 
(ii) restore the original allocation by adjusting your monthly SIPs by investing less in equity fund and more in debt and liquid funds; 
(iii) continue with your monthly SIPs and ride the bull rally a little longer - allowing the equity allocation to rise to 75% before choosing options (i) or (ii).

From the point of view of simplicity, option (i) is the least complicated. The reallocation is suggested after one year to avoid paying any long-term capital gains tax on your equity fund profits.

What about the answer to the question? As was mentioned earlier - you have no need for it.

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