This is how you should spend your stock market gains

Now the question you need to find an answer to is this – What do you do with all these extraordinary stock market gains? To help you along, here are some ideas to consider.

But first, look at your portfolio. See how your stocks are allocated. Also check the quality of stocks you own – remember, a rising tide lifts all boats. Poor-quality stocks often rise as much, if not more, than good-quality stocks. What you want to avoid is a situation where the tide runs out, and you are stranded with junk. So, the first thing to do is consider getting rid of the poor-quality stocks.

Next, look at your portfolio allocation. Check to what extent you are overexposed to the racy segments of the market i.e. the small caps, midcaps, be they stocks or funds, or even portfolio management schemes. If you are overextended here, as compared to your original plan, and you don’t have the appetite for sharp drawdowns, then this is another area you need to cut back. Again, start with the poor-quality stuff and work your way from there.

Finally, take a look at your overall asset allocation. I am talking about how your funds are allocated across various asset classes like stocks, bonds, real estate et cetera. You are likely skewed in favour of stocks, given the rally. What you do here depends on who you are. If you have another five to ten years to use this money, then perhaps you can live with a lopsided allocation (given that the next few years could be good for the Indian economy, and perhaps, the stock markets too – no guarantees though!). On the other hand, if you have needs coming up in the short term, then you need to rebalance again.

Now, what do you do with all the cash that will be generated by these actions?

First, to the extent you can reinvest in stocks, you may have luck on your side. It seems, to me at least, that quite a few blue-chip stocks are available at relatively reasonable valuations. In case you are wondering, let me clarify – Just because a stock is a large cap it’s not bad. In a similar vein, not all small caps are high quality stocks. What you need to see is the potential for return, given the risk you are taking on. And today that’s in favour select mostly large blue-chip stocks. So, spend some of your profits/reallocation money on effectively improving the overall quality of your portfolio, and setting yourself up, potentially, lucrative risk-adjusted returns.

Second, keep some cash. For two purposes – beefing up your emergency fund corpus. It never hurts to have a bigger emergency corpus. And some to grab potentially lucrative stocks as and when the stock markets present an opportunity i.e. a sharp dip for a non-fundamental reason. All of us know such instances happen regularly. Yet few ever plan to capitalise on them. Having cash in the bank feels like a crime! But the fact is that this is what you need to do to really juice up your returns. In case you need motivation – Warren Buffett is presently sitting on over $150 bn in cash, waiting for the next big opportunity!

Finally, spend some of the money to improve the quality of your life. If it’s more than a bit, buy a holiday home where the air is breathable! (If you are in Mumbai currently, cough-cough, you know what I am talking about!). This may perhaps turn out to be your best investment yet!

Before I conclude, here are some thoughts on what you should consider not doing:

First, avoid the urge to hold on to poor quality stocks, or worse, adding to them. Perhaps, the stock market could continue to rally. But if history is any guide, we know sooner or later all bull runs end. And the worst hit are the racy poor-quality stocks. Many, never recover making the losses permanent.

Second, if your core view is that the markets will continue to do well, there’s often this desire to amplify returns by using leverage. While this may work for some, when you take on leverage (be it by borrowing money, or trading F&O), you are betting your future on it. No return can be worth taking that kind of risk.

Finally, the talk of the town, once again, is cryptos – perhaps the best-performing asset class of 2023. Now, I don’t get cryptos as deeply as some do. But I can tell you this with a high degree of conviction – perhaps 99% of investors are ill-suited for it. And the reason is the same – hardly anyone has any clue of what it is, and where it is headed from a regulatory perspective et cetera. So, before you take the leap, once again, think hard!

Rahul Goel is the former CEO of Equitymaster. You can tweet him @rahulgoel477.

You should always consult your personal investment advisor/wealth manager before making any decisions.