Stock market investors have had a good run in the last three years. But what to do with the wealth that you have generated from the stock markets today? Let’s look at ways to lock in those gains. After all, the only thing worse than not making a lot of money, is making it, and losing it!
Here are three simple ideas on how to lock in those gains.
First, and this is perhaps the most crucial, the surest way to lose your stock market gains is to continue remaining invested in bad businesses. Whether such stocks have done well or not for you, you need to get rid of them. These stocks take the hardest hit when markets turn for the worse. Some prime examples of such stocks from past bull runs are Mazda Industries (1992), Global Tele , Pentamedia and HFCL (2000), and Reliance Power, Unitech and Reliance Capital (2008). You will note that these are often very popular stocks that rally purely based on narrative. Their valuations are completely out of whack with reality, and yet, money continues to chase such stocks. And then of course, they completely destroy shareholder wealth. Look out for these characteristics in stocks you own and dodge potentially massive destruction of wealth.
This first step is perhaps also the most difficult to execute. In a rising market, such narrative driven stocks gain the most with the FOMO (fear of missing out) factor kicking in hard. You don’t want to sell out and miss out on ‘potentially’ large gains that are “just around the corner”. Perhaps, one way of working through this is to ask yourself – Is it better to lose 20% upside, or avoid an 80% downside?
Second, the time to take more risk for more return is perhaps over. Such investments are made in times when few are excited about the prospects of high returns from stocks. Today, everyone is excited about earning super high returns, and this has driven up stock prices to levels that have conversely limited the potential for future returns. How do you counter this? Well, you take some risk off the table. You do this by moving money from the ‘high risk’ bucket to the old, boring, and far cheaper large cap blue-chip stocks (the “low risk” bucket). When I say high risk, I am generally referring to investments where valuations are factoring in irrational expectations. This is where the chance of taking a big hit is the highest. I would include small-cap stocks in this category. Moving some money from high-risk to the relatively low-risk bucket could give you far better downside protection, without giving up the potential for earning solid, but realistic, returns going forward. Old is gold could once again hold true in time to come.
Third is a counter intuitive idea. To avoid notional wealth destruction in the ‘long term’, you should avoid selling stocks of well-managed companies with strong businesses that have stood the test to times . No matter what their valuation. Some will agree with this idea, most won’t. But the fact is that real wealth is created by people who hold on to great companies for a long period of time. In this world of fast moves, you will be tempted to believe you can move out at the peak, and then move back in post the sell off. Perfect market timing is an illusion, which is yet to be realised for real.
Warren Buffett said, “The stock market is a device for transferring money from the impatient to the patient.” Be super patient. Get working on it!
In conclusion, another of Buffett’s wonderful quotes, “investing is simple, but not easy”, holds true as ever. Like the three ideas to lock in your stock market gains shared above. But as we both know, without the complications, investing in not much fun! So, in comes the trading, the racy stocks, the leverage and what not. This keeps you busy…it keeps you in the game. But in most cases, the net result is a big zero, if not a minus.
As we sit perhaps near the top of a market cycle, it may be wise to heed the advice of the investing greats. And consider implementing some basic changes to lock in your bull market gains.
Rahul Goel is the former CEO of Equitymaster.
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Published: 16 Jan 2024, 11:30 PM IST