It’s a question we get asked quite frequently, particularly when the equity market appears to have recovered from a few weeks’ worth of malaise. When the Sensex recently crossed the magical 20,000 mark, quite a few Squirrels asked us if it was time to “book some profits” on their equity portfolio.

Is there an answer to this simple question: “When should I sell my equity holdings?”

Yes, there is, and as with most investment questions, the answer is, “It depends.”

Of course it depends on who you are and what you hold and what stage of your life and your investing cycle you’re in and so on. But it can be distilled down to three simple thumb rules.

Sell when you need the money for something meaningful. Perhaps you want to pay for a new or bigger house for your family and you to stay in. Or you need to fund your daughter’s college education. Those are meaningful uses for the money. Using the money to buy a second house that you hope will appreciate is not meaningful – it’s merely changing your investment strategy, which is the topic of a whole other discussion. Using the money to buy a swanky Audi that will give you joy for a few years and then inevitably succumb to depreciation and potholes is not meaningful – it’s an indulgence. You need to decide what’s meaningful for you, but don’t divest equity for indulgences.

Sell when you need to re-balance your portfolio. As you get along in years you need to re-balance your portfolio either because your risk profile changes (as you get older, you don’t have the luxury of waiting for returns via capital appreciation, so you need to increase the proportion of less risky assets in your portfolio) or you need more income-generating investments to replace the salary you will no longer be paid. So, periodically review where you are in life, how your portfolio is doing, what your income needs and expense requirements look like and then decide on divesting some of your equity portfolio to park the money in fixed income holdings that generate a regular income.

Sell when you are making extraordinary profits in a short time. This is a trickier one because what constitutes extraordinary profits and what constitutes a short time both tend to be subjective. Decide whether the profit is extraordinary by comparing it to the rest of your life. Say, you’ve invested Rs. 1 lakh in some equity portfolio. A few months later, the stock market goes exuberant and the Rs. 1 lakh is now Rs.2 lakhs. Certainly, 100% qualifies as an extraordinary profit. But if you’re also currently earning a salary of Rs.50 lakhs per annum, a gain of Rs.1 lakh is about a week’s income. Not so extraordinary after all. If, however, you’re earning a salary of Rs.12 lakhs each year, then a lakh of profit is a month’s salary. Not too shabby.

A useful measurement tool you can use is seeing what you can do with the profits you’ll make if you were to divest. Can you use the money for something meaningful? (And don’t forget the unfortunate reality that most meaningful uses for money involve significantly meaningful amounts of money!) Or are you going to squander it away or be forced to reinvest in something that’s not offering a decent return. If the answers are No, Yes and Yes respectively, then don’t divest.

There are related questions such as, “How much should I sell?”, “Which investments should I sell?” and so on.

The answers to these will depend on which of the three reasons for selling applies to you. If you’re selling to achieve some meaningful goal, then you’ll sell as much or as little as you need to get you closer to that goal. If you’re selling to re-balance your portfolio, then you only need to sell enough to achieve that new balance. If you’re selling because there are extraordinary profits on the table, then sell enough to recover your original investment or sell enough to shave off the normal profits (there are good arguments for either of these approaches and you can decide which to use based on what you can do with the money you get).

The trick to making equity investing work for you is to give it time. Loads of time. In the short term, equity yo-yos more than most. In the long term, a good equity portfolio retains value and appreciates better than most investments.