Booking Profit From Funds: Now or When?

Booking profits requires just a click, yet, accumulating a sound investment corpus takes time. Therefore, rushing into booking profits without reconsidering the decision might harm the patiently amassed corpus. The report suggests the right way of going about it 

If you are a long-term investor who has commenced the investment journey early, chances are that you have experienced both market upswings and downturns. You would have persevered during tough times, potentially doubling your investment when valuations were favourable during market downturns. Perhaps now, you might be sensing that the market could undergo a significant downturn, considering it’s currently trading at all-time highs. Such a fall may potentially erode the profits on your investments. [EasyDNNnews:PaidContentStart]

However, it’s essential to note that the Indian markets are trading at higher levels owing to the strength of the Indian economy as compared to the other countries and its own historical values. While it’s certainly plausible that the market could experience volatility over the next few months due to the upcoming Union Budget next month and the general elections, it doesn’t necessarily imply that the market will take a U-turn from this point and see a significant downturn. 

As such, many of you may be wondering if it is the right time to take profit from the table rather than when one should book profits from the funds. Let’s delve into the current dilemma of when to book profits. There should be a strong reason to book profit or exit from your funds. When equity indices touch new highs, it does not necessarily mean that you should exit from the funds and book profit. In fact, had you stopped or booked profits a year ago some time at the end of November and start of December 2023, not only would it have reduced your accumulated investment, but it might also have led to missing out on the compounding effect, which demonstrates its magic over the long term. 

Avoid Timing the Market

Purely booking profits from your funds, even if your investment goal hasn’t been achieved, indicates an attempt to time the market, as if the market has peaked and cannot rise further. Reflect on the past when the Nifty stood at 17,000 in March 2023. Did anyone accurately predict that it would reach 21,000 within the same year? Even analysts suggesting a surge to 24,000 this year could be right or wrong—only time will unveil the reality. Timing the market remains an intricate task, and there is no perfect formula to predict correctly and in a timely manner. Hence, there is no reason to book profit when the markets are high. It is hard to digest profit. Many investors become impatient and regret it afterward. 

Focus on the Goals

Have you ever heard your father talking about saving small, consistent amounts for your sister’s marriage since her birth? If so, you can relate to the point here. Saving and investing for her marriage serve as the goal for the investments, ensuring financial stability during that significant event, avoiding the stress of arranging funds when needed. Therefore, hypothetically, the goal here is your sister’s marriage, which means that the investment should only be redeemed when the goal is near completion or in urgent situations that cannot be managed otherwise. 

Before contemplating booking profits, reflect on the goal or objective for which you began investing your hard-earned salary in various mutual funds. Your goal might be your daughter’s marriage, your education abroad, your child’s education, or starting your own small-sized business. Ask yourself this question: How far are you from your goal? 

For instance, if you set a target to start your own business by 2030 and began investing during the pandemic in 2020, then with only three years having passed out of the intended 10, evaluate if your invested amount aligns with the target capital needed. Completing either the time-wise or amount-wise goal warrants considering booking profits, else, reassess your decision. If you are very close to your target capital or event, booking profits may be appropriate. 

Tapping the Golden Opportunities

It might be possible that you are presented with a golden opportunity to invest in another asset class, which rarely occurs in a lifetime. By investing in this opportunity, you could potentially generate handsome returns, especially when comparing the expected returns from this point onward, considering the recent significant upward movement in the market. Anticipating volatility in the future until the budget or election, contemplating booking profits might be a prudent decision. However, if there isn’t any alternate opportunity available, and the sole intention is to safeguard your profit, it might not be a wise decision. Doing so could tempt you to spend extravagantly on luxuries. 

Fund Performance

Whether you are invested in equities or mutual funds, tracking performance is an ongoing task. Without doing so, you may find it difficult to decide whether to stay invested or book profits. You need to be aware of whether the fund in which you have invested is performing well or not. Analysing performance in isolation is not desirable. It should be compared from the perspective of both its benchmark and its peers. 

If it is not performing well for a couple of quarters or more, and is unable to beat both, it is the right time to dig deeper, especially with an actively managed fund. If you find it’s a problem with the fund, then in such a scenario, you should consider booking profits. However, this doesn’t mean using those funds for luxuries. Before booking profits, one should find an alternative investment for reinvesting the corpus. 

Tracking the Fundamentals
 

When a mutual fund scheme changes its fundamental attributes, existing investors are given a one-month window to exit the scheme without incurring any exit load. Some changes, like a switch in the fund manager, might not significantly affect the risk-return proposition of a scheme because generally there is more than one fund manager to manage a fund. If a change doesn’t match an investor’s goals or risk tolerance, they should consider redeeming their investments. Yet, if a change leads to better risk management or offers the possibility of higher returns with only a slight increase in risk, staying invested might be advisable. 

Sometimes, a scheme from an acquired fund house gets merged with schemes from the acquiring fund house. Typically, the merged and surviving schemes have similar investment objectives and patterns. If a reputable fund house with strong processes takes over another, investors may not need to exit the scheme, otherwise investors should evaluate them in relation to their investment goals and risk tolerance before deciding. 

Rebalancing or Diversification
 

Diversification is always necessary to safeguard investments and reduce the impact of market volatility in a portfolio. Diversification is effective across all fields. You have probably heard the quote: “Don’t put all your eggs in one basket”' Similarly, if you have invested in a specific sector—for example, infrastructure, IT, power, or in a particular category like Large-Cap, Mid-Cap or Small-Cap funds—consider booking profits if better performance has increased its weightage in your portfolio. 

You can book profit from such funds and invest in funds that will lead to providing diversification benefits. It’s also essential to consider the ratio between equity and Debt Funds in your portfolio. If it is inadequate based on your goals, age, or your risk appetite, you must rebalance your portfolio, which entails exiting from certain funds. 

Booking Profits to Save Tax

In India, long-term capital gains (LTCGs) on equity mutual funds held for over one year are largely tax-free, up to a limit of Rs 1 lakh per financial year. This ‘sweet spot’ offers an excellent opportunity for investors to engage in tax harvesting, a strategy to optimise your tax liability and boost your overall returns. Let us understand with an example. For instance, if your investment in equity funds gives you a return of around Rs 1 lakh, and you book the profit after holding it for over a year, you need to pay tax on it at a rate of 10 per cent as long-term capital gains (LTCG). 

However, these capital gains are tax-free up to Rs 1 lakh. This means that you don’t need to pay tax if it’s within this limit. In a similar scenario, let’s say you didn't book the profit as mentioned, but instead, you continued to hold the investment for the next year, and the profit increased to Rs 1.5 lakhs. Now, when you redeem your profits, you need to pay tax on the difference, which is Rs 50,000 (Rs 1.5 lakhs – Rs 1 lakh), amounting to Rs 5,000. This surplus is taxed at a rate of 10 percent as it exceeds the threshold limit. 

This implies that if you had booked your profit earlier when it was within the exemption limits, you wouldn’t have had to pay the tax that is now applicable since it has exceeded the exemption limits. Remember, tax harvesting is a strategic financial technique, not a quick fix. By understanding the rules, choosing the right funds, you can leverage the Rs 1 lakh LTCG exemption and maximise your returns while minimising your tax burden. 

Conclusion

You should always understand that there is no one-size-fits-all answer to when to book profits from mutual funds. The decision should be based on your individual circumstances and financial goals. Booking profits should ideally align with your financial goals, risk tolerance, and overall investment strategy. Regular reviews of your portfolio’s performance and periodic reassessment of your investment objectives will guide you in making informed decisions regarding profit booking from mutual fund schemes. 

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