Consider a portfolio of Rs100 which was up 35% for the year and was trading at a value of 135. A sharp fall in the markets brings down the portfolio value to 100.
Now assume there is a brilliant investor who did book his/her profit of 35% before the fall.
Quick quiz, that you need to answer in ten seconds. In terms of % how much is this investor better off from the lay person who did not book their profit?
Psychologically most of us will anchor to the 35% profit and believe that the investor would have probably saved close to 35%. If not 35%, one will tend to believe that the smart investor would have definitely saved quite a bit by selling before the large fall from 135 to 100.
Now that you have your quick answer, let’s look at the math.
If your account for the fact typically even a good timer will not perfectly time the top and bottom and may be off by a bit i.e. he/she may sell closer to 130 and buy back when the portfolio is closer to 110, the investor will probably be better off only by 4–5%.
This wasn’t immediately clear to me and i am sure it isn’t to many investors who use mental short-cuts to arrive at conclusions.
Attempting to book your profits when you are up 35% and buying it back post a 26% fall in the market may seem like a big money-saver but it isn’t even close, especially if you consider the slippage from top and bottom, the emotional roller-coaster, transaction costs and taxes.
The point of this article is not to say that the 5% that a decent market timer saved doesn’t matter (it’s great if someone can do that consistently), but that we often in our heads think that the we could have saved a whole lot by timing these crests and troughs, which may not be all that true.
If you’re curious, the only way to have “saved the full 35%” was to sell 100% of your portfolio — something most of us wouldn’t ordinarily do.
The author, Prabhakar Kudva is Co-Founder and Director of Samvitti Capital.