42-year-old Rohit is quite happy with his investments. The stock market is touching all-time highs now and then. And his SIPs in equity funds are witnessing stunning double-digit returns. Given the quick bounce back from the covid-19 market crash in 2020 and the next rally in the stock market, Rohit is hopeful that markets will keep touching new highs. However, in the back of his mind, he is also worried about a possible market fall wiping out all his gains.
Rohit is not alone. Many investors are also skeptical if the markets can sustain this growth. They wonder if it is time to book profits and wait for the correction to start reinvesting. On the face of it, this step sounds logical, but is it practical? Is it the best investment strategy at this point? After all, there is a possibility that the stock markets could continue to rally further.
In this blog, we will address all such dilemmas to help you figure out how to invest at market highs. To begin with, let’s first find out if this is the right time to sell or stop your equity investments.
Should You Stop Your Equity Investment At Market Highs?
One of the best ways to answer if you should sell or discontinue your investments in equity is to find out how justified this fear is that markets fall after every rally in the market. To get some perspective on this question, let’s look at how markets have moved in the past.
There have been 63 months in the last 20 years since January 2000 when the NIFTY 50 ended a month on a new high. And only in 23 months, the markets fell after a new high. In other words, there have been 40 months in the past 20 years when the stock market kept rising to clock new highs after new highs.
Year | Number Of Months When NIFTY 50 Ended On A New High | Number Of Months When The Markets Corrected After Ending On A New High |
2000-2005 | 12 | 4 |
2006-2010 | 19 | 5 |
2011-2015 | 12 | 5 |
2016-2021 | 20 | 9 |
Total | 63 | 23 |
Therefore, the equity markets do not necessarily witness a correction after every new high. However, even rising equity markets provide enough opportunities to generate returns. So, it is not a great idea to sit on cash and miss the rally just because the stock market has touched a new high.
Even if you invest only at all-time highs, the chances of you earning good returns are quite high. We know it is pretty difficult to believe that, so we looked at the historical data. We took into account all the instances when the NIFTY 50 had hit an all-time high in the past 20 years and then looked at the 1-year, 3-year, and 5-year returns that NIFTY 50 offered from these all-time highs.
Investment At All-Time Highs
| % Of | Times | Occurred |
|---|---|---|---|
NIFTY 50 TRI Returns Post All-Time Highs Since Jan 2000 | 1 Year | 3 Year | 5 Year |
More Than 12% | 58 | 28 | 42 |
More Than 8% | 64 | 56 | 68 |
0-8% | 73 | 87 | 100 |
As the table shows, even if you had invested only at all-time high levels during the past 20 years and stayed invested for at least 5 years, you would have still earned positive returns 100% of the time.
More importantly, nearly 7 out of 10 times, you would have earned more than 8% returns and beaten the inflation by a decent margin. Remember, these are only all-time highs. So you would have comfortably earned double-digit returns had you invested during slight dips in the market.
These data points simply highlight that while the stock market may seem higher in the short term, you will never know which point is the end of the rally. Therefore, sitting on cash or redeeming all your equity investments just because the stock market is setting new highs are not good ideas. Nevertheless, this does not mean that you do nothing following a market rally.
You need to make changes in your portfolio after a significant correction or a rally, but these changes should be in accordance with your asset allocation. Because your asset allocation mix will change as markets rise, you need to bring it back to its original mix. This process is called Rebalancing.
Rebalancing – Prudent Investment Strategy At Market Highs
When there is a rally in the stock markets, check if allocation to equity in your portfolio has risen significantly. Because if your portfolio’s allocation to equity has increased considerably, your portfolio has become more risky and volatile. In that case, your investment strategy should be to rebalance, i.e., bring it back to the original level you are comfortable with.
Let’s understand rebalancing with an example. Say the total size of your portfolio is Rs. 10 lakh. You want 60% of your portfolio invested in equities and the remaining 40% in debt. Your equity portfolio is further split to 35% large-cap, 20% mid-cap, and 5% small-cap. This means you have Rs. 3.5 lakh in large-cap, Rs. 2 lakh in mid-cap, and Rs. 50,000 in small-cap. The remaining Rs. 4 lakh is in debt.
As the equities have rallied in the last year, the large-cap, mid-cap, and small-cap grew by 47%, 62%, and 77%, respectively. On the other hand, the investments in debt only grew around 6%. Such a stark difference in the performance of different schemes would change your targeted asset allocation significantly.
Change In Asset Allocation Due To Market Volatility
Asset Type | Target Asset Allocation | Investment As Per Target Asset Allocation | Change In Last 1 Year | Investment Value After 1 Year | Changed Asset Allocation |
Debt | 40% | ₹4 lakh | 6% | ₹4.2 lakh | 31.4% |
Large Cap | 35% | ₹3.5 lakh | 47% | ₹5. 1 lakh | 38.1% |
Small Cap | 20% | ₹2 lakh | 62% | ₹3.2 lakh | 24% |
Small Cap | 5% | ₹50,000 | 77% | ₹88,500 | 6.5% |
As the table shows, your current asset cllocation would have moved from a 60-40% equity-debt mix to nearly 69% in equity (38.1% large-cap + 24% mid-cap + 6.5% small-cap) and 31% in debt.
This means equity is 9% in excess, while debt is short by 9%. In other words, your portfolio is riskier and more volatile than you are comfortable with. This is why you need to rebalance your portfolio and bring the asset mix back to 60% equity and 40% debt.
To rebalance, you will have to sell equities and use that money to increase debt investments. Alternatively, you can also increase your investments in debt and pause your investments in equity till you reach the 60-40% equity-debt mix.
How Will Rebalancing Benefit?
You may find rebalancing a strange strategy. After all, you will be selling parts of an asset class that has done well in the past year and use that money to invest in assets whose recent record has been relatively poor. But what you are doing with rebalancing is you are investing in assets when they are relatively undervalued and selling them when they are relatively overvalued.
Therefore, rebalancing is a disciplined way of investing, much like investment in SIPs. In SIP, You get more units of a mutual fund scheme when the market is down and fewer units when the market is up. This averages the cost of buying the mutual fund units, and you benefit in the long run. Similarly, through rebalancing your asset allocation, you will be increasing equities in your portfolio after a steep correction in the market and selling equity following a rally in the market.
We have a detailed blog on rebalancing that proves how rebalancing your portfolio can beat a pure equity portfolio by a good margin. For example, the blog shows if someone had rebalanced their portfolio for the last 15 years between equity and debt, they would have earned a 1.3% average annual return more than someone who did not rebalance and stuck to a pure equity portfolio.
Bottom Line
Selling equity investments or holding cash just because the SENSEX of NIFTY 50 is setting new highs is a mistake on several levels. First, when investing, it’s critical to make decisions based on long-term expectations, not short-term market moves. Second, setting new highs doesn’t necessarily mean the market has peaked, and a correction is imminent.
Thus, a prudent strategy to invest at market highs is to rebalance your portfolio. This is a smart investment strategy because asset allocation acts as a counterweight to the prevailing trend.
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