Major purpose of periodic review

A major purpose of periodic review is to identify securities for disinvestment. If a security is overpriced in relation to its intrinsic value (the purchase price is irrelevant), it should be sold so that the proceeds can be invested elsewhere. Disinvestment, of course, is often abhorred by investors who find it easy to invest but difficult to disinvest. Yet, to succeed in the investment game you must not only know when to invest but also when to disinvest. There is a time to buy as well as a time to sell. So shuffle your portfolio, if necessary, on the basis of your reviews.

Most investors review their portfolios superficially. They scan their portfolio and merely take note of paper profits and losses. To do well in the game of investing you should however, go further and re-evaluate each commitment in a detached fashion. Though it is difficult psychologically, you must take a determined effort to do this. Suppose you have 500 shares of Alpha Company stock which is selling currently at Rs 120. Ask yourself a simple question: Having Rs 60,000 of cash today and buying some stock, would one choose the shares of Alpha Company in preference to other options available? If the answer is strongly in the negative you should sell your holding of Alpha Company. Remember that your purchase price, whether it was Rs 50 or Rs 150 should not matter. Your original cost is irrelevant.

One should take a cue from many outstanding investors who keep a systematic record of their investment decisions. Maintain a notebook with a page for every security in your portfolio. Write down why you have bought and later why you have sold. Periodically review your completed transactions to understand the psychological reasons, if any for your mistakes.

In a bull market book profits, even if you believe that the bull run has some steam left in it. Off load your holdings in installments. Be contended with the profits you realize. Don’t wait greedily to sell when the market reaches its peak. It is like chasing a chimera. If you don’t contain your avarice, your paper profits may evaporate as the market declines.

A practical problem in switching from one security (whether it is a stock or a bond) to another (whether it is a stock or a bond) is related to taxes. Let us look an example to understand the issues involved. Suppose SS has bought 1,000 equity shares of A Limited for Rs 25,000 six months ago. The current market price of these shares is Rs 50,000. SS believes that these shares are somewhat overpriced and considers the scope for appreciation over the next one year to be somewhat modest. He expects the price per share to be Rs 55,000 a year hence. He is considering the possibility of selling these shares now and investing the post tax sales proceeds in the shares of company B, which he expects to appreciate by 15 percent over a one year period. What will be the expected post tax amount in SS’s hands a year hence under the followings options:

Option 1: Hold shares of A and sell them for Rs 55,000 a year hence.
Option 2: Sell the shares of A now, invest the post tax proceeds in the shares of B, and sell the shares of B a year hence.

For evaluating the two options, we will ignore dividends for the sake of simplicity;

Option 1: Hold the Shares of A

1. Expected market value of shares one year hence Rs 55,000
2. Post tax realization Rs 55,000

Option 2; Switch from the shares of A to the shares of B

1. Current sales realization Rs 50,000
2. Purchase cost (six months ago) Rs 25,000
3. Short term capital gains Rs 25,000
4. Tax on short term capital gains Rs 2,500
5. Post tax realization Rs 47,500
6. Current investment in the shares of B Rs 47,500
7. Expected market value of shares one year hence
(Rs 47,500 x 1.15) Rs 54,625
Post tax realization Rs 54,625

Option 1 is recommended —

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