• HDFC
• 25 Oct 2018
• Equity Product

HDFC, Tester

Sharp corrections like the one witnessed recently in the country’s stock market in Sept-Oct-18 raises a question for those who follow the principle of investing for the long term. Long-term investors witnessed individual stocks owned by them falling by 20 - 40% from their recent highs. They have wondered as to whether they should have sold in better times to raise cash, then re-enter the market at lower levels.

 

Let’s take a look at the reasons and situations in which an investor should sell.

 

1. Better opportunities: Sometimes, there’s absolutely nothing wrong with a company or its stock. There are simply better investment opportunities elsewhere that would yield higher returns.
2. Changes in the business: Businesses change – sometimes significantly. These could come in the form of major acquisitions, modifications in the industry’s fortunes, a change in the management or its style of working, or a shift in the competitive landscape. When this occurs, investors should check if the reasons for which they purchased the stocks of the company are still relevant. If not, investors should consider selling them, regardless of the current prices. Holding on to these could dilute the quality of the investors’ portfolios, and also their long-term performance.
3. Valuation: Long-term investors should also consider selling if the stock price escalates to a point where it no longer reflects the underlying value of the business. Additionally, investors should re-examine their evaluation of a company’s fundamentals when its stock suffers an unusual decline in its price. When the bubble bursts, stock prices will not rise to the previous level until the fundamentals improve again. Opportunity cost is the value an investor could get from an alternative investment. Investing money in a stock that is in the doldrums implies that it is not deployed elsewhere that could prove to be more profitable, and with scope for growth going forward.
4. Faulty investment thesis: Investors should seriously consider selling a stock if it turns out that their rationale for buying it was flawed, if the valuation was too optimistic, or if there are any risks associated with it.
5. It keeps the investor up all night: If an investment’s price has plunged in a way that it causes investors to lose sleep over it, it is a signal for them to move their money elsewhere.

 

How to protect portfolios from downside risk?

 

Diversification:

 

Investors can reduce their downside exposure by making sure that their investment is diversified across individual stocks and sectors. This is particularly important for those with insufficient time to conduct research or go into the details of industries and individual stocks. During a recession, however, this theory may not hold true. This is where diversification amongst negatively-correlated asset classes can be of some help.

 

It is wise for investors to ascertain the maximum percentage of their portfolio that they are comfortable with being invested in a single stock. At the end of the day, it is up to investors to weigh the risks and rewards that come with the allocations in their portfolios.

 

Negatively correlated assets:

 

An asset with a negative correlation with respect to stocks simply means that when the price of the said stock falls, that of the concerned asset rises. By investing in negatively-correlated assets, investors are effectively hedging them. However, in the case of a black swan event like the Lehman Brothers’ crash in 2008, even the prices of negatively-correlated assets can fall together.

 

“You, far more than the market or the economy, are the most important factor in your long-term investment success.” ~ Burton Malkiel
There is a phenomenon called the behavior gap that implies that individual investors could buy and/or sell at the wrong time, thus damaging their long-term returns. It is not only regular investors for which this holds true. Professional investors can also make investments that underperform the market as a whole, year after year.

 

The last stages of a bull market can often be the most lucrative, but it is always better to invest in the long term.