4 questions to ask before you sell equity

An investor, let’s call him Mr D, recently posted this on social media.

Over the past six months, my equity portfolio showed an appreciation of around 25%.

The World Bank reduced India’s GDP growth forecast for 2021-22 to 8.3%. Since growth was -7.3% in 2020-21, this means over two years India’s growth will be 0.49%. High inflation in edible oils, fuel, LPG and medicines will hit consumption. 

But money is flowing into the market. I am selling at this tidy profit. I will re-enter after a significant correction.

I don’t think Mr D realised that he was playing out Bill Bernstein’s advice. Years ago in a media appearance, investment guru Bill Bernstein famously said: “If you've won the game stop playing.”

He went on to explain that before the Global Financial Crisis of 2008, many investors had “won the game”. They had pretty much saved sufficiently for a comfortable retirement. Yet, it was greed that egged them on to continue taking risks. Afterward, many of them sold either at or near the bottom and never bought back into it, irretrievably damaging their portfolios. themselves. So, “when you've won the game, why keep playing it?”

But before you follow in Mr D's footsteps, I suggest you answer these questions.

My biggest investing goof-ups

Ask: What is making me cautious?

Mr D believed that there is a disconnect between the economy and the stock market's meteoric rise, coupled with the fact that the market is flushed with liquidity (Investment by FIIs in Indian equities hits a 2-decade peak). So according to him, the bubble could burst any time. Inadvertently, Mr D arrived at the logical conclusion that it is not so much the time spent in the market, but rather the point in the business cycle.

But if you are a stock investor, you will have to make the call on each individual stock. Maybe some stocks are not overvalued, while others may be extremely overvalued. You cannot use the “market levels” argument to make a blanket call.

If you are a fund investor investing systematically, you may decide to discontinue further SIPs if you are uncomfortable. But this also depends on your investing time frame. If it is a decade down the road, please do not stop – consistency works to your benefit.

Which instantly brings us to the next question.

Ask: Can I afford to take the risk?

How risky equity is to you will depend on which part of the life cycle you are in. If you have a really long runway to your goal (most probably a young investor), there really is no perceivable market risk. For the middle-aged, yes, you better be cautious. For a retired person, it is pretty risky.

There is often a disconnect between risk tolerance and risk capacity.

Risk tolerance is how much you can lose without feeling mental turmoil. Risk capacity is how much you can lose without changing your plans.

As you get closer to retirement, your risk capacity declines, even though your risk tolerance may still be that of a 25-year old. You will have to draw a balance between the two. The same applies if you are a 25-year old who prefers to err on the side on caution.

Are you focusing on the wrong risk?

Ask: When will I return to the market?

Market irrationality can last a very long time. So when do you plan to return? Do you have a specific market level in mind?

Let’s say you are waiting on the sidelines. The market drops by 10%. You wait. It drops by another 10%. You wait because you are convinced it will fall further. It declines another 10% and now you are convinced bad days are coming, so you want the market to bottom out. And what if it suddenly begins to rally and you missed timing the bottom? You would have lost out investing at lows and not caught the rally either.

Once you are out, it is difficult to psychologically get back. And till then, you will have to figure out where to park your savings.

That is why timing is not a good strategy.

Ask: Will my decision to sell move me closer to my goal?

John Bogle once narrated this incident where at a party on Shelter Island, Kurt Vonnegut informs his pal Joseph Heller, that their a hedge fund manager host may have made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responds, “Yes, but I have something he can never have. The knowledge that I’ve got Enough.”

In Enough: True Measures of Money, Business, and Life, John Bogle makes some pertinent observations. “Rampant greed threatens to overwhelm. Not knowing what enough is subverts our values. This confusion about enough leads us astray in our larger lives. The worship of wealth results in the growing corruption of our ethics, the subversion of our character and values.”