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Investors are often advised to buy equity funds and to stay invested for the long term to achieve optimal returns. However, an equally important aspect—knowing when and how to exit—often takes a back seat or is overlooked.
There is no doubt buying quality equity funds and staying invested in them for the long-term will help generate optimum returns. Surprisingly, this may not be enough to achieve and realise these returns. Eventually, it boils down to when and at what levels one exits in the equity markets, which truly decides the trajectory of the returns.
As per historical data, investors who stayed invested over the long term and, sold equity funds during good market conditions at higher levels proved to be more successful in achieving and realising optimum returns.
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Should investors buy at any level in the equity markets?
Ideally lumpsum investors are recommended to buy at lower levels and exit at higher levels and for systematic investment plan (SIP) investors the starting point does not matter much but are strictly recommended to exit during good market conditions at higher market levels.
Let us understand this with an example. Say, if one got lucky and bought BSE 100 TRI in March 2009 during the global financial crises (lower market levels) and sold in 2019 or 2020 before or after the covid fall (higher market levels), one would have achieved around 17-18% CAGR returns. However, if one sold in March 2020 during the covid fall (lower market levels) one would have only achieved around 12% CAGR returns despite of buying in March 2009 (lower market levels).
On the other hand, if an investor started an SIP (systematic investment plan) in January 2008 (higher market levels) and continued till January 2020 (higher market levels) the investor would have achieved around 12% CAGR returns. But if they sold in March 2020 (lower market levels), the investor would have only achieved around 5-6% CAGR returns.
This example clearly shows that the exit point and selling during good market conditions at higher levels is utmost and more important for all investors (especially SIP investors) to achieve and realise optimum returns.
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Now that we know when to exit to optimise returns, the next question arises: how to follow the exit strategy?
First and foremost, investors should understand that they need to be extremely lucky to buy at the exact bottom and sell at the exact top in the equity markets which can be very difficult as no one cannot accurately predict. The best and easiest way to take an exit call is when the valuations (particularly price to earnings ratio) of the underlying equity product’s portfolio and markets start becoming expensive by trading at decent premium levels over and above their long-term averages. This indicates that the equity product and markets have entered premium valuation/higher level range which can be a good time to exit.
Secondly, exiting will be subject to taxation and churning frequently will break the process of compounding which can put a dent on achieving optimum returns. Thus, to avoid denting returns, investors should primarily sell when they absolutely need money or when their goal amount is nearing or has been achieved. Regardless of the market levels, if one has achieved the goal amount, it is wise to completely get out of the equity markets and not fall in any kind of greed.
Thirdly, if one has stayed invested for the long-term and, depending on the product’s nature, if active equity funds underperform on the basis of a 5-10-year return versus their respective benchmarks by a decent margin, then it is important to exit from those funds and venture into consistently outperforming ones. Let us not forget that investors are silently paying an extra fee, which automatically drains out of these active funds for outperforming returns.
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Fourthly, investors can even look at partial exit to reduce risk in their portfolios. Say, if an investor allocated 50% towards mid and small caps or 50% towards overall equity and over a period of five years the allocation shifted from 50% to 70% then the investor may rebalance to reduce risk based on the latest risk profiling. But if the investor is comfortable with taking risks and has a further medium to long time horizon, staying invested is the wise thing to do to benefit from the power and process of compounding.
Rushabh Desai is founder of Rupee With Rushabh Investment Services. Views are personal.
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