With the Sensex scaling new heights every day, there is a sense of deja vu. When the tech rally was just gathering steam in the middle of 1999, there were several skeptics shouting themselves hoarse about rising stock prices.
But, as stocks continued to defy gravity and valuations sky-rocketed, even the savviest of investors lost their self confidence and relented to rally. Sure, the rally time is built on sound fundamentals. Here are five golden rules you need to remember in your encounter with the roaring bull.
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. Given the exuberance in the stock market now, it may be wise not to be overweight on equities.
In other words, commit exactly what your financial planner would suggest depending on your age and other financial goals. More importantly, you need to review the portfolio periodically and rebalance it.
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 purchasing 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.
Also, it is important to remember that 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 stock 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," says a leading fund manager. 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.
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. In fact, several stocks have more than doubled over the past one year. So it may be time for investors to take home some profits.
If you feel that your investments are adequately valued, you should exit regardless of how long you have held them.
Rule 5
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 that your analysis was flawed or that you got carried away, 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.
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