Is it a good time to book profits? If not, then when?

Booking profits is easy, but building a strong investment portfolio takes time. Rushing into profit booking without careful thought can risk your gains.

As investors, we all love the thrill of seeing our investments grow. Yet, deciding when to cash in on those gains can be a daunting task. It's like walking a tightrope between securing profits and missing out on potential future gains. So, how do you navigate this tricky terrain?

Booking profits may seem easy with just a click, but building a solid investment portfolio takes time and patience. Rushing into profit booking without careful consideration can risk your hard-earned gains. As a long-term investor whether you have an investment in Large-Cap, Mid-Cap, Small-Cap, or multi-cap funds you've likely weathered market ups and downs, potentially doubling your investments during favourable market conditions. However, when markets trading at all-time highs, there's a concern about a possible downturn. While market volatility is encountered today due to election results, it doesn't guarantee a significant market reversal.  So, the question arises: when should you book profits? It's crucial to have a strong reason to do so. Just because the market hits new highs doesn’t automatically mean it's time to cash out. Let's break it down in simple terms.

Avoid the Temptation to Time the Market

Trying to predict the market's every move is like trying to catch a falling knife – risky and often futile. Market highs and lows can be unpredictable, and trying to time them perfectly is a gamble. Remember, even the experts can get it wrong.

Focus on Your Goals

Before considering booking profits, reflect on the goal or objective for which you initially invested your hard-earned salary in various mutual funds. Your goal could be funding your daughter’s marriage, pursuing education abroad, covering your child’s education expenses, or starting your own small-sized business. Ask yourself: How close are you to achieving 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 timewise 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.

Any Golden Opportunity Available?

You might come across a rare chance to invest in a different asset class, offering potentially high returns, especially considering the recent market upsurge. However, if there are no other investment opportunities and your main goal is to protect your profits, it might not be wise. This could lead to the temptation of indulging in unnecessary luxuries.

Keep Tabs on Fund Performance

Regularly monitor the performance of your mutual funds. Compare them not only against their benchmarks but also against their peers. If a fund consistently underperforms or deviates from its objectives, it might be time to reconsider your investment.

Stay Grounded in Fundamentals

When a mutual fund undergoes fundamental changes, investors usually have a month to exit without facing any exit charges. While certain changes, like a new fund manager, may not drastically alter the fund's risk-return profile, others may not align with an investor's goals or risk tolerance. In such cases, redeeming investments might be necessary. However, if the change improves risk management or offers higher returns with only a slight increase in risk, staying invested could be wise.

Diversify Your Portfolio

Diversification is crucial for protecting investments and mitigating the impact of market fluctuations. As the saying goes, "Don't put all your eggs in one basket." If you've heavily invested in a specific sector or category, such as infrastructure, IT, or large-cap funds, and their performance has significantly increased your portfolio's exposure, it might be wise to consider booking profits. By doing so, you can redistribute those profits into other funds to enhance diversification. Additionally, it's important to assess the balance between equity and Debt Funds in your portfolio. If it doesn't align with your goals, age, or risk tolerance, rebalancing your portfolio by exiting certain funds is necessary.

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 optimize 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 per cent 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, and choosing the right funds, you can leverage the Rs 1 lakh LTCG exemption and maximize your returns while minimizing your tax burden.

Conclusion

There's no one-size-fits-all approach to booking profits from mutual funds. Your decision should be guided by your circumstances, goals, and risk tolerance. Regularly review your portfolio, stay informed about market trends, and make decisions that align with your long-term objectives. By doing so, you'll be on track to maximize your profits while minimizing risks along the way. Equities are known for their volatility, offering the potential for multibagger returns. On the other hand, people often opt for mutual funds for peaceful investing and steady growth over time. Happy investing!

Disclaimer: The article is for informational purposes only and not investment advice.