Investment advice and strategies always focus on how to invest. You are advised to invest according to the asset allocation suitable to your goals, research investment options thoroughly and invest regularly to make market volatility work in your favour. But buying into investments is just one part of the investment plan. For the plan to be really successful in meeting its objective of getting you to your financial goals, an efficient exit strategy is as important as an entry strategy.
The strategy should focus on identifying the situations that warrant exit from an investment and how best to execute it.
Triggers for Exit
Sell when goals have to be funded: An investment portfolio is built to meet goals. The investments need to be liquidated to generate the money required to fund the goals when they are due. This is best done in stages, which would take care of the twin considerations of protecting the corpus that has been created and ensuring that the money is available when the goals have to be funded. In the first stage, redeem the long-term growth investments that have been used to accumulate the corpus and move the funds to less-volatile investments, such as debt products, to protect their value. This is best done 1-2 years before the goal has to be met. In the next stage, when you are closer to the goal, redeem the debt investments and fund the goal.
Sell to restore balance: The asset allocation in a portfolio may have moved away from the desired proportions on account of a run-up in the values of one or more class of assets relative to the others. This may skew the risk-and-return of the portfolio in a manner that may no longer be suitable to the investor’s needs and goals. For example, a run-up in equity values may increase the proportion of equity in the portfolio and make it riskier than what an individual close to retirement is comfortable with. In such a situation, it is financially prudent for the investor to sell a portion of the equity investments to reduce the proportion of equity in the portfolio and invest the proceeds into the other asset classes so that the portfolio’s risk and return characteristics are restored.
The advantage of following the policy of selling an appreciating asset class to rebalance is also that you book profits in the investments periodically and at the same time you invest into other suitable investments when their prices may be low. Set an upper limit for deviations from the preferred asset allocation and rebalance when this is triggered.
Sell to reflect change in goals and risk tolerance: Investments held in a portfolio may become unsuitable when goals have changed or the risk tolerance of the individual has changed. For example, a change in circumstances, such as greater job security, may now make goals more long-term and increase risk tolerance. The portfolio that may have had a debt-orientation to reflect the lower job security and risk tolerance may no longer be relevant now that income is secure. You may be ready to make your funds work harder for better returns, albeit with greater risk. When goals change, switch funds to more suitable investments by selling the investments that are no longer relevant.
Sell when profits targets are met: A portion of a portfolio may be held to benefit from an expected appreciation in an asset class in the near-term. This is the tactical segment of the portfolio and the funds are typically not linked to any goal or need. The idea is to sell as soon as the expected profits are made. For this to work efficiently, it is important to have an exit strategy in place.
Waiting for the markets to peak before you sell may be risky since it is impossible to predict or time the markets. You may instead see profits erode as prices decline before you have had a chance to sell. A better strategy is to have a profit target, say 20%, and sell the position when the profits materialize. Or, have a target for a relevant index and sell when that trigger is activated.
Sell when performance is poor: Despite going through a rigorous selection process, it is important to track investments to ensure that they are performing as expected. Have a system to check the performance on a quarterly basis against a suitable index as well as peer group investments. Investments that consistently under-perform over 3-4 quarters should be earmarked for sale. Holding on to poorly performing investments will pull down the overall portfolio returns and money will be working less hard than it could for you.
The temptation is high to ignore triggers to sell and stay invested when markets are rising. Similarly, the reluctance to sell at a loss may result in holding on to poor performers even when they are clearly dragging down the portfolio’s returns. Executing an exit strategy on investments requires discipline and clearly defined processes. Where possible, liquidate the investments over a period of time to reduce the risk of selling at a point when the price is low. Consider the tax and cost aspects of selling investments and use the provisions provided in the Income Tax Act to set off gains against losses made to maximize post-tax returns.