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(Precious) Words of Wisdom : "Wall Street makes its money on ACTIVITY, you make your money on INACTIVITY." ~ Warren Buffett

In Mutual Funds You DON'T Have To Book Profits

To invest in equity, you either buy stocks directly or invest in equity-based mutual funds.

However, as often warned, the proven practices that apply to direct investment, should NOT be blindly applied to mutual funds too.

This also holds true for one of the most common rules in equity investment — Profit Booking.

Suppose you bought 1000 shares of Company A at Rs.100/share. Your total investment - Rs.100,000.

Few years later, the market price of Company A stock is quoting at Rs.150.

Great! You are sitting on profits of Rs.50,000.

Now, what will you do?

Going by the general rules of equity investing, you will book your profits. (If you believe that the stock is overvalued, you will sell your entire holding and take home all the profits. Or, if you think the stock has still some steam left, you will book partial profits.)

But the key question is what next? What will you do with the sale proceeds?

Some people play safe and invest the amount in debt investments. This is a good option, provided your risk appetite is low to moderate. So you keeping taking out profits and reinvesting the same in safe products. However, this approach affects wealth creation, as the immense benefit of compounding is lost. But still, something is better than nothing.

Most people, however, move the profits booked on an overvalued stock to another which, as on that date, is undervalued. And, this process continues. In other words, from time to time they churn their portfolio. This is a good option, when your risk appetite is high and you won't require the money in the coming few years.

This broadly is what one does with direct equity investment.

STOP the (wrong) practice of profit booking in mutual funds.

Let's now take the story forward to mutual funds.

Suppose you bought 1000 units of Mutual Fund X at NAV of Rs.100/unit. Your total investment - Rs.100,000.

Few years later, the NAV of Mutual Fund X is Rs.150.

Great! You are sitting on profits of Rs.50,000.

Now, what will you do?

Going by the general rules of equity investing, you will book your profits.

But the key question is what next? Now, what will you do with the sale proceeds?

If, like the first option discussed for direct equity investment, you move your profits to safe debt investments, well and good. For a moderate-risk investor, this is a good strategy.

Now, to the crux of this article... 

However, you could be horribly (horribly) wrong, if like direct equity, you believe that at NAV of Rs.150 the Mutual Fund X is now "overvalued". Hence, you sell it and move your money to a so-called "undervalued" Mutual Fund Y.

People often make this mistake... in the mistaken belief that they are selling an "overvalued" scheme.


(Firstly, as all financial experts have mentioned a million times, in mutual fund investing NAV is 'Not Applicable Value'. It does not, in any manner whatsoever, indicate whether the particular mutual fund is overvalued or undervalued).

More importantly, the fund manager managing the portfolio of stocks, is far more knowledgeable and experienced than you. Plus, s/he is monitoring the portfolio on a day-to-day basis. So, from time to time, s/he would sell the overvalued stocks and move the money to undervalued stocks. In other words, s/he is churning the portfolio on your behalf.

Effectively, therefore, even though the NAV has increased, the portfolio continues to be undervalued. Hence, Mutual Fund X continues to be great (great) investment. There is no reason, whatsoever, to "book profits" if the sole purpose is to move from one mutual fund scheme to another.

The success story of many mutual fund schemes in delivering — and continuing to deliver — excellent returns to its investors over the last two decades, is a testimony to this fact. [Must Read: How Rs.1 Lakh Became Rs.1 Crore In Mutual Fund Scheme]

Concluding: It pays to invest  and (almost) forget — if you are invested in a good mutual fund scheme. A quick look, maybe once in six months, should be good enough to ensure that the fund is on the right track. A few rare cases of under-performance observed during this review, could be restructured. But surely NO profit booking, in the conventional sense of the term.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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