Once you start earning and take control of your finances, it is important to do some financial planning. This might involve doing different types of investments such as Mutual funds, shares and so on. There are plethora of investment optionsavailable for you to choose from. It is always better to have some strategic planning in place if you aim to be a long-term investor.
Investing for longer times might also have episodes where you would want to book profits depending on the market movements of your financial needs. However, what is profit booking in investment and whether or not you should book a profit? Let’s take a look.
Definition of Profit Booking in Investments
In simple terms, profit booking is nothing but liquidating your holdings to cash out the profit. For e.g., if you have invested in some shares and their prices soar higher, then you might want to redeem those shares to earn some profit, avoid losses and re-invest them in some other asset if required. As tempting as this sounds, many a time this may not be the right decision.
Whether you decide to invest through SIPs (Systematic Investment Plan) or lump sum, you might face this dilemma sooner or later. Here we share the two important things that you need to keep in mind while booking profits.
It is practically impossible to predict a correction or a downturn
In varying degrees of probability, the market may continue to move upwards and set a new high all through the year. However, the reverse is possible too. Any type of outcome can be expected. Hence, when it comes to long-term investments, one should not decide in haste based on short-term market expectations.
Keep in mind your asset allocations before deciding
Asset allocation is when you diversify your investments into different assets such as equity, real estate, debt, etc. Generally, assets are divided into equity and debt. Equity investment is where you invest money in a company by purchasing its shares that are then traded on the stock market. Debt investments are where you loan money in return of your principal amount plus the interest. Debt investments can be corporate bonds, Government bonds, a savings account, Certificate of Deposits (CD) etc.
The division of equity and debt investments depends on you. However, let us assume you have a 60-40 equity-debt allocation. If the market value changes, then so should yourallocation. In this case, if you notice that equity assets in your portfolio have shot up significantly so much so that your division is 70-30, then this might be the right time to book the profit and get your allocation back to the original division. This way you can maintain the risk-return balance in your portfolio.
To understand the importance of investing, it is vital to know that for long-term portfolios, profit booking should be a function of your financial goals and the ensuing asset allocation rather than the market trend at any point. Happy investing!