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6 golden rules for a bull market

March 29, 2004

The Smart Investor spoke to market mavens and investment pros to distill the essence of good investing approaches for a roaring bull market. We have a list of six golden rules to maximise gains from it.

Rule 1: Stick to the desired asset allocation

Asset allocation is the key to successful investing, say experts. Even though equities may outperform debt substantially, it will not be wise to put all your investments in equities.

Investors should allocate assets among various asset classes - primarily equities and debt - based on their risk appetite. Being overweight by about 10-20 per cent in equities may be justifiable, say fund managers.

In other words, if you are advised to allocate 20 per cent of your investments into equities based on your risk profile, you could consider a maximum exposure of 40 per cent currently given that equities are poised to surge ahead.

"Being 20 per cent overweight in equities is justifiable considering the relative attractiveness of equities," says Dileep Madgavkar, chief investment officer, Prudential ICICI Mutual Fund.

It is important to review the portfolio values periodically and rebalance the portfolio. In bullish times, the value of equities tends to rise faster and the equity portion in the portfolio can become disproportionately higher. Downsizing the equity component to stick to the original allocation can help in guarding asset values when the markets fall.

Rule 2: Distinguish between stocks for keeps and trading

When you buy a stock, be clear about your objective behind the purchase - whether you have bought the stock as an investment or a trading bet. Trading stocks are not bad as such. But they require you to work harder and act quicker.

Rule 3: Buy with adequate margin of safety

That's where attractive purchase prices can help. As a matter of fact, selling stocks is no different from buying them.

"If you get into a stock because it is undervalued, by the same logic, you should get out when it is overvalued. The key is to understand the worth of the stock at any given point," says Raamdeo Agrawal, managing director, Motilal Oswal Securities.

He recommends keeping a sufficient margin of safety when buying a stock and not relying on making a good sale ever. "As long as I am prudent in deciding my purchase price, even a mediocre sale gives me a good return on investment, or at least helps me conserve my capital," says Agrawal.

Rule 4: Sell when value is realised

Some stocks may rise sooner than you may have anticipated. In a frenzied bull run, investors may see their target prices being met in a matter of days. Here time should not be of any consequence.

If you feel that your investments are adequately valued, you should exit regardless of how long you have held them. There are times when stocks begin to quote at extraordinarily high levels within a short period after you have invested in them.

Although investors are often advised to invest for the long term in equities, if you get extraordinarily high returns within a short span, it is wiser to get out, say experts.

Rule 5: Keep a watch on relative valuations

The real cost of a stock is not the price you pay for it, but the opportunity cost of not putting your money in another stock with a greater potential to rise. Let's say you hold a smaller pharma company and find that a larger one is also available at the same multiple.

It may make good sense to switch. "A larger company, with more liquidity and visibility, will be preferable," said Prashant Jain, head of equities, HDFC Mutual Fund, in an earlier interview with The Smart Investor.

While buying a stock most investors look to buy the cheapest of the lot. Indeed, that is the right approach. However, it may not be a good idea to buy a stock just because it is cheap in relative valuation terms.

Explains Jhunjhunwala, "When stocks become overvalued there is little logic in holding on to them just because they appear cheaper than others." He would not count on the fact that a greater fool will emerge to buy your stock.

Rule 6: If you realise a mistake, exit

Even while we are talking about selling stocks in a bull market, experts emphasise that if investors make mistakes, they should exit immediately even at a loss.

If you realise your analysis was flawed or that you got carried away for any reason, it's good to get rid of a stock as soon as possible. Waiting for a better price at such instances may prove to be quite dangerous.

A few tips

Buy and hold/wait for the market to come back: Financial professionals typically encourage investors to diversify their investments, buy stocks with solid fundamentals, and hold them until they are ready to retire.

Averaging: It is a process of buying a fixed rupee amount of an investment at regular intervals, and is often praised by the investment industry as the best approach. The investor, who allocates a certain amount of money monthly or weekly into his investment fund, buys whether the market goes up or down.

Although the portfolio will lose money when the market drops, the shares purchased at increasingly low prices will add that much more to the bottomline when the market turns back up.

Never use a stop-loss: If you do, you might take yourself out of a winning trade prematurely, right? This is really just another way of looking at the buy-and-hold attitude. Long-term investors often don't have cut-off points.

Risk control for investors comes in the form of diversification and, hopefully, conscientious selection of assets like quality stocks and bonds. Conservative investing consists of buying relatively stable areas of the market, and then sitting back and letting the market do its thing.

Never short the market: For most people, investing rightly means owning an asset that can eventually be sold at a profit. If you try to time the market, you'll usually miss out on more than you have lost had you stayed in from the start. So, investors cannot afford to short the market to buy back later.

Focus on fundamentals: If you buy or sell State Bank for investment with a time horizon of at least six months, then focus on its fundamental characteristics - balance sheet, company value and earnings potential.

The price at which the scrip is available should be less than the value determined by you and leave a margin of safety in case the earnings potential does not materialise.

Source: Motilal Oswal Securities

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