Hello Everyone! Booking profit is as important as making the investment itself. But it can backfire drastically. So, today we will get to know 5 reasons why you should not book profit in a haste. Well, we have all heard a story of the man who had a hen that laid golden eggs. He thought the hen must be having a lot of golden eggs in her stomach. Instead of getting one egg at a time, why not cut open her stomach and get all the eggs at once? He went ahead and cut open the hen. He found that the hen was no different from any other hen. The moral of the story is that one must not hurry to get big returns. A small but steady stream of returns, will eventually result in wealth accumulation and achieving the desired goals.
Let’s now see the 5 reasons why you should not book profit in haste.
Reason no.1: Denting of Long Term Goals
A significant part of investments one makes, is to help achieve long term objectives such as acquiring a house or steady income for the post-retirement period. One must remain invested in such investments for the period for which they have been set up. One must ignore events such as sudden increases in market value and remain committed to steady, periodic returns. If profit is booked at such events then this dents the long term goals ultimately ruining your financial strategy which is very risky in the long run.
Reason no.2: Loss of the Compounding Effect
Let us first understand ‘the compounding effect’. If an investment of Rs. 100 is done @ rate of 10% per year for a period of 5 years, then you might assume that you will be getting Rs. 10/- per year. Which means Rs 10 x 5(years) = Rs. 50 at the end of 5 years. Well this is not how compounding works. Let us check this table to be more clear. (Please note: figures are rounded off to keep it simple.)
Year 1 = 100 + (100 x 10%) = 110
Year 2 = 110 + (110 x 10%) = 121
Year 3 = 121 + (121 x 10%) = 133
Year 4 = 133 + (133 x 10%) = 146
Year 5 = 146 + (146 x 10%) = 161
At the end of the decided period of 5 years the actual ROI = Rs. 61 and not Rs. 50.
This is the power of compounding – it can give s higher returns in the later years. But if profit is booked in a haste, then one will lose the compounding effect.
Reason no.3: Wrong decisions due to ‘Herd Mentality’
‘Herd Mentality’ is a behavioural pattern where people tend to blindly copy actions of other people by following their lead. Generally this happens as a reaction to an adverse event or even a rumour of an adverse event like “Markets are going to crash!” etc. When profit booking is done under such circumstances, it is a clear example of decision made in a haste without any introspection. Always avoid such situations and keep a broader perspective in mind, focussing towards your long term goals.
Reason no.4: Risk of Re-investment
In a situation where profit is booked abruptly i.e. before the decided period of the planned investment, you would be in a position of surplus cash. Now the challenge is the availability of more profitable avenues for such booked profits in a haste. Sometimes it is possible that one may be forced to invest it in other investments that may bring-in lesser returns than the original investments itself, making it ultimately a risky affair.
Reason no.5: Tendency to use such quick profit for unplanned expenses
The availability of a significant surplus amount can result in instant gratification i.e. by making immediate unplanned expenditures. Generally resulting in purchase of depreciating assets like purchase of a car, premium electronic goods, luxury items etc. or even simply an unplanned vacation abroad. This is another challenge faced due to booking profit ahead of time.
Well, now you know the 5 reasons why you should not book profit in a haste. We hope you have learnt something new today, as it is our constant endeavour at Motilal Oswal to educate & make an ‘investor’ a ‘sound investor’! Happy Investing!
