Why it does not make sense to get into cash partially

Of late there had been a lot of chatter about booking partial profits – get 25% into cash and keep the balance 75% into equities. This strategy essentially indicates two piquant flaws:

1)     that the investor is unsure about the future

2)    That he is broadly bullish (75%) and partly bearish (25%)

I did this calculation when many of my acquaintances went into this 25% cash business and this is what I got:

1)     No one sold off at the top the chatter started well before we had made the top at around 11,000 or thereabouts

2)    I have taken an investor who sells out at an index level of 11,000.

3)    The portfolio size is assumed to be Rs 500,000.

4)     It is assumed that:

  Case A: He missed the bottom. That is exactly                       

              what happened

            Case B: He entered at the rock bottom level of         

                         the index at 8800

Case (A)

Therefore by getting 25% into cash you were able to relatively out perform the other person by only 5%. That is not what we are in the markets for.

Case - B

Now assume that the investor has caught the cycle correctly (next to impossible)

Now why would I do all this for a mere 6.25% gain in my portfolio when the chances of missing the entire rally are far more then the odds of getting back in.

What has gone wrong in the above computation? The above computation reflects a confused investor. Who is predominantly bullish (75%) and partially bearish (25%). The market never pays for confusion and chaos. More often then not this investor will never heed to his mistake and always justify why prices should fall a bit more. When prices do start moving finally he would feel comfortable in getting into those stocks that have not moved – that would disturb matters further.

Where does the problem lie? The problem does not lie because the markets are going down. It lies in our choice of stocks. The real crash management system will have 20% of the portfolio dedicated to solid long term secular growth stories like HDFC, HDFC Bank. These stocks are least effected at the times of a crash and do recover back very fast. Investors are normally undecided as how much to allocate between the different companies. The third grade B!/B2 scrip from the BSE find more exposure then is warranted. This falls faster and harder while the recovery is slow..

If investors get worried about an impending crash the best way is to sell out of these speculative buildups and get into solid blue chips which will out perform the markets in case it decides to tank.

So I would suggest that crash management systems lies in enhancing the quality of the portfolio rather then changing the asset class per se.

Conclusion: Even a best case scenario would have made a gain of 6.25%. Now people did tell me that some stocks went off 50% from the top and we could have made 50% in them so in that case our existing portfolio (75%) would have been affected by 50% as well.

No one, I repeat no one can extrapolate the market’s behavior because the markets run on the collective wisdom of all the participants. This “collective wisdom” is influenced by subjective factors of fear and greed.

Booking profits-that is usually bad unless valuations have gone way ahead of reality(because good stocks usually run up in the long run and as Phil Fisher Says something like- unexpected good news keeps coming up) unless you are sharp enough to be able to latch on to something better consistently and that is very difficult but achievable for a period as I know it.