The Hindu Business Line : Difficult to avoid entry-exit pitfalls

THE above story suggests that even if you are prepared to hold your investments for ten years, the timing of your entry and exit into stocks can influence your returns.

Two strategies are suggested to lay investors to avoid the pitfalls of timing.

These are rupee-cost averaging and periodically booking profits based on target returns.

Both may help protect investors to some extent, against downside risks in equities. But remember, neither gives a guarantee of good returns.

Rupee cost averaging no guarantee of robust returns: Take rupee-cost averaging. Phasing out your investment in a steadily rising market may help deliver better returns than sinking a lumpsum into stocks at the height of a bull market.

For instance, Rs 60,000 invested in the Sensex between January 1990 and December 1994, in instalments of Rs 1,000 per month would now be worth Rs 1.18 lakh. If the entire Rs 60,000 been invested at one go in December 1994, it would be worth just Rs 55,100.

Rupee cost averaging has thus helped the investor avoid the pitfalls of losing value on investment due to a badly-timed entry. But the final returns after ten years would still be influenced by the fact that much of the initial investment was made in buoyant market conditions.

In the above instance, even if an investor phased out his investment of Rs 60,000 through monthly instalments, the final value of investment, Rs 1.18 lakh, translates into a compounded annual return of no more than 9 per cent.

Booking profits on target returns: The second strategy usually suggested to investors to avoid the problems of timing is regular profit-booking on investments based on target returns. An analysis of how this strategy works in practice shows that it does help to protect investors against downside risks of the market.

But profit-booking based on a target return of, say, 25 per cent would have also led to an investor missing out on some of the best phases in the stock market over the past ten years.

Take the case of an investor who started out with a corpus of Rs 10,000 in January 1990 and took out the profit portion on his investment, after attaining a target return of 25 per cent, based on a review of his investment every year. By June 2003, his investment would have been worth Rs 53,100.

This is significantly better than the Rs 46,300 that would have been earned by the investor who invested Rs 10,000 in January 1990 and did not bother to check his investment thereafter, till June 2003. But the annualised returns from such a strategy, at around 13 per cent, are not much higher than the 12 per cent earned under the buy-and-hold strategy.

The significant outlays on taxes and transaction costs that would go with periodic profit booking may also take away a significant portion of the incremental returns from such a strategy.

What ten-year returns say: Finally, what does the analysis of ten-year rolling returns say for investors in equity? For one, it reiterates certain important investment tenets for equity investors:

Starting early with equity investments is not as important as starting at the right time. An investment of Rs 10,000 made in the Sensex in September 2001 would today be worth Rs 12,800, whereas a similar investment made nine years back, in September 1992, would be worth a much lower Rs 10,900.

If you have entered equities at the height of a bull market, you cannot bet on the fact that the investment will generate acceptable returns if you hold on long enough. It may be better to seek opportunities to cut losses and re-deploy the proceeds at a more favourable time.

Big moves in the stock market and in individual stocks happen in short bursts. Investors can maximise returns by taking advantage of such action to book profits.

This is especially true of stocks such as Hindustan Lever, Reliance or ITC, which operate in mature businesses. Even in other stocks(see table), the range between the highest and lowest ten-year returns is vast. This suggests that profit-booking in periods of high returns has a big pay-off.

Many of the above points only underline the fact that investing in the stock markets is a complicated business. The odds favour the possibility that you will make an acceptable return if you buy the right stock and hold it for the long term. But you cannot entirely rule out the possibility that you may end up with measly returns, even after a ten-year wait.

It may, therefore, be best for unskilled investors to route equity market investments through equity mutual funds with a consistent track record. True, professional managers too, cannot be expected to get their calls right all the time and may make expensive mistakes. But they certainly have the advantage of tracking the equity market more closely than do lay investors.

Even a cursory glance at the returns earned by equity mutual funds launched in the early 1990s (such as the Franklin India Bluechip or the Prima) makes it clear that an actively managed fund can build wealth more efficiently than direct investing in equities, over a long time frame.

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