Investment Objectives & Advice

Buy, Sell or Hold?

In last 2 weeks, Nifty has corrected by ~10%. It is not the extent of correction but the speed of correction, which made many people raise the age-old question: Buy, Sell or Hold. Some of the possible thoughts popping in head can be as below:

  1. If the market start gaining the lost ground, we might miss the opportunity to buy cheaper
  2. If its going to fall more, I should wait and buy cheaper
  3. If the fall is going to be deep, should I sell the current holding and later on buy cheaper

This is also not the first time, when people asked me this question and I am sure it won’t be their last. The trouble is that everyone wants an answer as yes or no, very rare ones want to understand how to reach that decision for himself. if you are in the rare ones, you might gain some insight from the below approach else you can stop reading here itself.

The query for buy, sell or hold emerges from two angles: When you gauge that the market levels are dislocated vs your perceived value or you are sitting on losses in your portfolio (I have not seen any people asking should I sell, while sitting on 15%+ annualized returns). I have earlier covered in quite a detail about “When to sell your investments”, main points as below:

  1. When you require the cash for planned expenditure or emergency expenditure
  2. When you are optimizing for taxes: Managing the capital gain tax or Harvesting the tax loss
  3. When you made the wrong investments and you want to correct those
  4. When market levels are not in the correct valuation zone

If you want to sell because of the fourth reason, then don’t just sell it yet and probe further. The better question is “Do I need more or less equity holding in my portfolio vs the current holding” or even better will be to understand “How much Equity should I hold?”. Let me explain, why this is a better question with two examples:

Example 1: A 30 years old person in a stable job, significant corpus and no loans has all his portfolio in fixed deposits. Should he buy more equity, the answer in most cases will be yes though if he is new to equity that it might be suggested to start gradually and may be with a Dynamic Asset Allocation funds or Hybrid aggressive funds. Example 2:  Another 30 years old person in a business with irregular cash flow, significant corpus and have some business loans, has all his portfolio in equity funds. Should he sell equity, the answer in most cases will be yes though how much is still to be addressed.

How much equity should you hold depends upon for major parameters, below is my rough calculation:

{Risk appetite (0-25%) + Risk capacity (0-25%) + Market valuation levels (0-50%)} * Investment horizon (0 to 1)

Higher the risk appetite & capacity, more allocation to equity and depending on your time horizon short, medium and long. Market valuations should drive the other 50% allocation, which you can measure based on your barometer of choice my choice is Valuation index. Therefore, even if you have a higher risk appetite, capacity and markets are cheap for goals due next 1-2 years, you should have 0 equity allocation. Market valuations are just part of equity allocations required and not the only factor.

How should you calculate your equity allocation?

  1. You can check the risk appetite based on 5 simple questions and multiply your sore with 5%.
  2. You can calculate your rick capacity based on the 7 main parameter and multiply your score with 5%
  3. Lastly Market valuations can be accessed based on VI (5-1), 5 is cheap in green zone and 1 in case of red color. Multiply that with 10%

VI Index

Based on these parameters you get the % allocation to equities, now for the investment horizon you should multiply with a factor for 10 yrs far goal assume its one and for 1 year down the road its just 0.1.

Let’s take an example of Nikhil, a 35 yrs old, investing for his retirement 20 years down the line. His risk appetite is moderate 2.5, risk capacity is 3 and based on above chart the market valuation levels are at 2. His equity allocation should be 47.5% {(2.5 *5% + 3*5% + 2*10%) *1}. Now if the current equity holding is less than 47.5%, he should invest more and in vice versa situation sell some equities. If it’s closer to 47.5%, then just Hold. Follow this during the re-balance once or twice a year can make you a much better investor in long term and taking emotions completely out of picture.

Do let me know, how much equity should you hold and are you going to buy, sell and hold in the comments section or mail us.

Investment Objectives & Advice

Is Index PE ratio still relevant.!!!

When we saw the sharp correction in July, which is now tagged as worst July in 17 years, lot of people started to point out that the main reason of the same has been the higher valuation levels (It means higher PE Ratios). If that is the case, they should have forewarned us and not analysed it post the corrections. (Though, I did warn about it in Sep 2018 even when I have been on defensive portfolio for almost last 2 years almost.) One of the chart table, which is making rounds on the social media as well as WhatsApp forwards, is the below or similar. This is reflecting that investing on High PE ratio levels end up with negative returns over a 3-year investment horizon, while vice versa is quite profitable. Today we will try to understand if this is still true, if yes then how relevant it is and lastly what should we do to make it more useful for us.

PE Ratio


Is this still relevant?

The short answer will be Yes, but that might not suffice for our understanding.

Recently, PV Sindhu has won the gold medal for the first time in world badminton championship and became first Indian to do so. In the long-standing history of cricket, for the first time England has won the world cup. There are lot of events which proves that if we go just by the historical fact that England has never won the world cup, in that philosophy they should never win as well. Therefore, it is always important to put the statistics and history in perspective. For e.g. how many times the top 5 or top 10 ranked badminton player wins the world championship? Or How many times a favorite cricket team of time has won the world cup? The results would have changed drastically. Still a topple up like 1983 world cup can happen and you can not predict it with surety so always keep your options open.

Can we use PE values & historical returns for investing?

Yes and No, No because the world around us has changed a lot and a simple prediction saying that history will repeat is not good enough. If you look at the recent two changes in the index constituents you will realize that we have replaced HPCL by Britannia and now replacing Indiabulls Housing by Nestle, both these changes will push the PE of index much higher given the higher valuation multiplier to FMCG companies.

Yes, because if history does not repeat itself then it often rhymes. We do not live in the world of past there has been impact of inflation across these years as well as the credit cost has come down drastically.

What valuation data can be used for improved investment returns?

As I mentioned that the world of finance has changed drastically over last 2-3 decades, we are now slowly transitioning into a lower inflation and interest rate regime.

  1. The cost of credit is a big factor of equity valuation and PE multiples get impacted by the same, so if we have a lower interest rate scenario, we have to adjust the mean PE expected value upwards. I wrote about it in Sep 2018 post in details, please read the same
  2. To adjust for the inflation impact, we can use the Shiller PE or PE10 but that means you either calculate it at your end or use someone else’s hard work using google

Below is the chart of Nifty PE since Jan 2000 and its trend line moving up from 15 to >20 now.

Nifty PE History as of Aug 23 2019.png

Though I migrated a bit to a different valuation index which I feel has a better predictive power that just PE standalone. I use a mix of PE & PB valuation levels because we have moved into the landscape with higher PE levels but at the same-time we have become efficient and got lower PB levels. I wrote about its interpretation earlier this year in May 2019, Lessons from Nifty History. Most of this data is available on NSE website to be used or what you can simply do is follow one valuation metrics at the least (other options can be ICICI Pru Valuation Index or Motilal Oswal Valuation Index)

How to interpret & apply the valuations index into investment practice?

Below is the table which you can use as a reference point and apply on your portfolio, my 2 cents and quick suggestion will be to book profit when it is at 10+, stop new investments in equity if you already have sufficient exposure when it’s between 9-10. Also if it goes to 6-7 or below, buy more equity than your required asset allocation.

Valuation index interpretations

Hope this helps to navigate the equity markets in a more secure way than your current situation. To find our recommended funds, Please read Mutual funds.

Keep learning & Happy Investing!!