Arthgyaan

Supporting everyone's personal finance journey

Should you sell off your equity funds since the market is overvalued?

The stock market cannot be predicted, but lessons from history and some basic rules can help you decide what to do as the market keeps moving up.

Should you sell off your equity funds since the market is overvalued?


Posted on 16 Jul 2021
Author: Sayan Sircar
5 mins read
Get new post notifications on WhatsApp!

The stock market cannot be predicted, but lessons from history and some basic rules can help you decide what to do as the market keeps moving up.

Thinking about overvalued markets

📚 Topics covered:

Introduction

Note: This article was updated once the Nifty 50 reached a lifetime high on 24-Nov-22 after a gap from 18-Oct-21.

Nifty 50 reaches Lifetime high level on 24-Nov-2022

As stock market indices like the Nifty 50 or Sensex reach a lifetime high, many investors fear an impending market crash. This is a classic example of loss aversion, where the fear of probable loss is stronger than the chance of getting future gains.

Peter Lynch famously said,

“Far more money has been lost by investors trying to anticipate corrections than lost in the corrections themselves.”

This “loss” is due to missed opportunities - the market moves up while the investor either

  • waits on the sidelines with cash
  • or pulls out money while the market goes up further

or, alternatively, there can be a benefit in waiting in case the market eventually corrects.

There are multiple nuances to this, and we will explore them below, including a plan to deal with the current scenario.

Recent articles:
1 / 3
<p>A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.</p>
2 / 3
<p>This article explains the PFRDA announcement about a new default scheme under NPS Tier II for government employee subscribers.</p>
3 / 3
<p>As per SEBI rules, mutual fund investors must have nominees in their folios by 1st October 2023 or explicitly opt out. Otherwise they will face restrictions in selling units.</p>

Join the Arthgyaan WhatsApp community: You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

What happens if you invest at a market peak?

Lifetime high chart

There have been 507 cases of the Nifty 50 price index reaching a lifetime high (highest value ever on that date) from Jan-1993 till date. There has been a further 79 such cases from Mar 2020. This chart shows the Nifty price level (in log scale) in that period, and each lifetime high is shown with a yellow dot. The red dots show the 1-year return from the date of the lifetime-high value (axis on the right side).

Lifetime high distribution

The short answer is nothing horrible happens after investing at the lifetime-high level. From the 507 cases in the chart, the average 1-year return in that date range came at 10/7%. There is a 68% probability (346 out of 507 instances, i.e. around 2 of 3) where the return has come positive (22% average). Of the 1 of 3 (158 of 507) cases, there has been a negative return (average -15% return). The distribution is shown in the figure above.

This means that there is a 2/3 chance of regret, based on past data, that the market will go up from the current high levels while you wait on the sidelines. A probability greater than 50% in finance indicates a trend you should follow. This also shows what is intuitive (highs lead to falls) may only sometimes be supported by data.

What happens if you invest at market peak AND the market falls?

Lifetime high distribution after 1 year

If we look at the 1-year return precisely after one year has passed from the lifetime high in the cases, there was a negative return (i.e. in the 145 cases ) we see that there were 20 cases with negative 1-year return in the 2nd year and 125 cases with positive 1-year return in the 2nd year. This means that out of the 507 lifetime-high cases there are only 20 cases with consecutive negative year-on-year returns, i.e. a probability of 20/507 = 2.5%. So it is unlikely (only 2.5% or 1/40 chance) that if you invest at lifetime highs, you will make negative returns two years in a row.

Where are you in your life stage of investing?

Investors should be aware of the sequence of returns risk when investing.

If they are at the beginning of their investment journey, a fall will be beneficial for the long-term portfolio

  • the current corpus is much smaller than what it will be in the future
  • any investments today, after the market fall, will grow from a lower base

Investors in the accumulation stage should continue investing if their goals are not funded.

However, if you are at the beginning of retirement, a market fall will significantly damage the portfolio. Investors in this life stage should review their retirement buckets and rebalance them in case the allocation is improper.

Are your short-term goals adequately funded?

If you have goals due in the next 3-5 years, they should ideally be in cash i.e. safe investments in a bank FD or similar assets. However, suppose there are a lot of gains in equity. In that case, this is a good time to rebalance to fill the cash bucket to ensure enough money is held in safe assets for these goals.

What is the signal from your asset allocation?

Each goal should have a suitable asset allocation with its own equity-to-debt proportion. If the market has rallied, then it is likely that asset allocation is now equity heavy. This is a good time to invoke corridor-based rebalancing (if 60:40 is the target and allocation is now 65:35 say then rebalance to debt). If the crash has already happened, it is a trigger to rebalance from debt to equity.

Related:
The stock market has reached an all-time high. Should you buy or sell?

Conclusions

You cannot predict stock markets, but as an investor, you can

  • learn from historical data that life-time-high levels do not automatically lead to losses
  • take a decision based on life stage (accumulation vs retired)
  • you should use asset allocation to determine the next steps by rebalancing
  • investments while in the accumulation phase should be continued

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Worked out case studies for goal-based investing

Previous and next articles:

<p>Learn how to evaluate your active fund against a benchmark by combining return and risk</p>
Portfolio Review
How do you measure the performance of an individual mutual fund?

Learn how to evaluate your active fund against a benchmark by combining return and risk

Published: 15 July 2021

7 MIN READ


<p>The answer is just enough as per your portfolio goals: here’s how to calculate it</p>
Portfolio Construction
How much cash should I hold in my portfolio?

The answer is just enough as per your portfolio goals: here’s how to calculate it

Published: 17 July 2021

4 MIN READ


Latest articles:

<p>This article shows a handy ready reckoner for home loan EMI amounts for all tenures and interest rates along with the amount of principal and interest to be paid.</p>
House Purchase
How much EMI do I have to pay for my home loan?

This article shows a handy ready reckoner for home loan EMI amounts for all tenures and interest rates along with the amount of principal and interest to be paid.

Published: 29 September 2023

1 MIN READ


<p>A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.</p>
Retirement Reader Questions
How much money does this 39 year old investor need to invest per month to retire at 58?

A quick retirement calculation for a reader query who has a good amount of corpus already saved for retirement.

Published: 27 September 2023

7 MIN READ


Topics you will like:

Asset Allocation (20) Basics (8) Behaviour (10) Budgeting (11) Calculator (17) Case Study (6) Children (12) Choosing Investments (38) FAQ (6) FIRE (13) Gold (11) Health Insurance (4) House Purchase (17) Insurance (15) International Investing (10) Life Stages (2) Loans (9) Market Movements (13) Mutual Funds (29) NPS (6) NRI (13) News (9) Pension (8) Portfolio Construction (46) Portfolio Review (27) Reader Questions (6) Real Estate (6) Retirement (36) Review (12) Risk (6) Safe Withdrawal Rate (5) Set Goals (27) Step by step (14) Tax (37)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.

More posts...

Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled Should you sell off your equity funds since the market is overvalued? first appeared on 16 Jul 2021 at https://arthgyaan.com


We are currently at 299 posts and growing fast. Search this site:
Copyright © 2021-2023 Arthgyaan.com. All rights reserved.