VR Logo

The (il)Logic of Booking Profits

Booking profits is an equity traders' concept that mutual fund investors must leave behind

Is it time for profit booking, investors are asking? If you are a mutual fund investor and you are asking this question, you could be making a big mistake. To be fair, this question is an obvious one in a time like the current one. The stock markets have slackened in 2015 after a strong surge in the previous year. This idea of profit-booking (or profit taking) is an integral part of equity investing culture the world over. Investopedia defines it as "The act of selling a security in order to lock in gains after it has risen appreciably." You buy a stock, and when you feel it has risen as much as it is going to over whatever time period you are interested in, you sell it. That 'locks in' the gains.

It is a common saying among equity investors that no one ever lost money by booking a profit. That statement sounds like a clincher, and makes profit booking a no brainer. The problem is that investors in equity mutual funds have also adopted this idea. Here's a typical query among the ones that I've been receiving from equity fund investors, "I've been investing in XYZ fund for a long time. Now that the market has stopped rising, I have redeemed all my units in order to book profits. Where should I invest the proceeds now?"

What do you think is the correct answer to this question? Here's mine. If the investor has something to spend the money on, he should do so. Otherwise, he should invest it in an equity fund. And since XYZ fund has given him good gains, that's probably a good choice. Sounds like I'm making a joke, but that's probably because in equity funds, profit booking just for the heck of it is a no brainer, but in a different sense of the phrase.

Booking profits means that you think that an investment has reached a point when it has nothing further to offer in your time frame, and you would need to move the money to some other stock. It doesn't mean that just because a certain amount of profit has been made, you must 'book' it. If you immediately move the money to another investment, then you've unbooked the profit. This makes sense only if, for some reason, it's important for you to count your the profitability of each stock separately. If you are thinking of your investments as a portfolio whose gains matter as a whole, then it doesn't make much sense.

In any case, in equity funds, there is already someone--the fund manager--who's moving in and out of stocks that are there in the portfolio of the fund, as needed. Selling funds just because the market went up and has now had a bit of a pause makes no sense as an investment strategy.

Apart from a slavish adherence to a misapplied principle, I think the roots of this profit-booking in funds lies in simple nervousness. There is a special breed of investor who gets nervous at every uptick in the market. Every paisa gained brings to them heightened nervousness about whether it's about to be taken away. And when the markets pause even a bit, they scuttle away like a surprised mouse.

I guess every investor is a slave to his or her own psychology, but the nervous types' behaviour is specially self-destructive. It's Iikely that most of these people will pull out their money now. At every fluctuation in the market they'll feel happy that they've saved their profits. However, eventually, when the market is much higher, they'll invest again. At that point, they might well be at a higher risk.

At the end of the day, this profit booking is a way of trying to time the markets--something that rarely works out for investors.