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Should an investor stop investing in equity funds at a higher P/E ratio?

Dhirendra Kumar discusses the pros and cons of taking investment decisions based on P/E levels


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As per my understanding, it is risky to invest in equity at higher P/E levels as they are currently, should an investor immediately stop investing in equity funds at a higher P/E, specially when the chances of getting low P/E in near future is nil?
- Jagjeet

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A price-earning ratio is a function of growth of a company's earnings. A lower P/E ratio is indicative of markets being undervalued and therefore investing in equity is considered as a good option. But defining that whether the market is relatively cheap or expensive is very difficult. Markets can be expensive and they can remain expensive for a long period of time, as witnessed in 2005.

In general, an investor can take investment decisions based on P/E levels but there is a great risk that you will be left out of the market when the big moves happen. My basic advice will be to stay dominantly invested and manage something which one has a control on, like allocating your long-term and short-term capital. Formulate an asset allocation plan with long- term capital invested in equity and rebalance your portfolio in every one-two year or so. The idea is to enforce a disciplined investment behaviour based on controllable factors and not on the markets. Markets can remain expensive and you might end up missing a big run because markets will go up and down when you least expect it to. So having a ready asset allocation plan ensures that you will be able to participate in it.

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