What is Profit Booking?
Profit Booking Myth-Busters
What is Profit booking exactly? What are the myths about it and what are the actual truths instead? How should one approach profit booking? How should the profit booking be actually done? All these questions will be answered in this article today.
Example of Profit Booking
- Suppose there is an investor who had invested Rs. 10 lakhs. The value of that investment has now become Rs. 11 lakhs. When this happens there is typical mindset of the investor where in they say that they have to book this profits of Rs. 1 lakh. Their thought behind doing so is that, they will redeem this profit now and invest the amount again when the markets go down. They think that they have saved Rs. 1 lakh here and their Rs. 10 lakhs are still save.
- What they don’t know is that, when their investment goes down (when the market goes down), suppose by 10%, and becomes Rs. 9 lakh. Thus, their investment value becomes Rs. 10 lakhs (Rs. 1 lakh from profit + Rs. 9 lakh current investment value) itself. Here, they have hardly saved Rs. 10,000, as if the investment value still was Rs. 11 lakhs then the downside would have been of Rs. 1.1 lakhs, which is only Rs. 1 lakh now.
- Now, from here, when the markets again go up, they have lost on the additional gain in their that Rs. 1 lakh. Retail investors generally always go wrong with profit booking. They think that they have removed their profit and the investment is just principal which is safe. This wrong and this only partial profit booking.
What is Profit Booking actually?
- Actual Profit Booking would have been that the investor invests Rs. 10 lakhs. The investment value then becomes Rs. 11 lakhs. Then, the investor should redeem the whole amount of Rs. 11 lakhs and then invest them in some other asset class such as defensive assets like liquid funds or debt funds or FD’s.
- This would have been proper Profit Booking.
- Profit withdrawal cannot be called as profit booking. By doing so one can only reduce the risk associated with it by just 10%.
How do Advisors Manage Profit Booking?
Advisors can correctly inform and suggest the investor on what to do with the profits. And when investors don’t listen to the advices given by their advisor, is when they start thinking that their advisor is not doing anything for them.
Thus, to manage such attitude of an investor, the advisor may: –
- Move the profits to liquid or debt funds.
- They may even give the dividend pay-out option to the investors, because of which the investor starts thinking that they are now receiving monthly income (dividend). As a result of this option, a lot of mis-selling took place. A balanced fund of some fund house was wrongly sold stating that the fund will give the investors a guaranteed dividend of 1% per month. This is actually very difficult to do, which everyone understood later on. Eventually, the fund house also the knowledge of this after which they clarified that they have no where stated or written that will give the investors a guaranteed dividend of 1% per month. Even that bubble got burst.
- On the investors forceful insist, the advisor redeems the profit of Rs. 1 lakh and invests them in some other mutual fund of the same asset class. This way the investor thinks that his profit has been booked and for the advisor the investment is still in the right asset class or right place.
These are the typical mistakes done while managing profit booking. These should be avoided. A correct investment and profit booking approach is very important.
Profit Booking Strategies : Solutions For Correct Profit Booking
1. Constant Weight Asset Allocation
- In this the asset allocation is reviewed once every year.
- For example, one has invested Rs. 100, Rs. 50 in equity and Rs. 50 in debt. After a year, equity is giving returns around 20% and debt is giving 10% returns. So, now the equity value become Rs. 60 and the debt value becomes Rs. 55 and the total investment become worth Rs. 115. The investment strategy here should be 50-50. Now this Rs. 115 should be divided by 2, which come out to be 57.5. As the investment strategy is 50-50, Rs. 2.5 should be shifted from equity to debt.
- This is how an investor should do constant allocation yearly. No need to review the asset allocation every month.
- This strategy is generally suggested for those with huge investment corpus and no goals attached, and rather only want to create or preserve wealth.
2. Financial Goal Planning
- This approach is for the retail investors. And this approach should be process oriented and the process should be of financial planning.
- Goal Planning is an important part of financial planning. If the goal of the investors are 10, 15, 20, 25 years away, then they should stay away from this concept of Profit Booking. The investor shouldn’t disturb their investment before their goal is reached.
- Profit booking before the goal has been achieved can derail the investment from its path, which should be avoided.