Should you buy more stocks or sell, when equity market falls?

The first thing to consider is the reason for the fall in the overall market index and then the fall in individual stock’s prices


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iStockPhoto

Investors often ponder about the next steps when markets correct sharply. While initial responses may be to buy the good stocks, if the correction lasts for a while, you may get jittery and sell that stock—or even your equity mutual fund. However, the decision should never be made in haste. Consider the following factors.

Are fundamentals impacted?

The first thing to consider is the reason for the fall in the overall market index and then the fall in individual stock’s prices. Often a severe global event can trigger foreign institutional investors (FIIs) to withdraw from emerging markets like India. This leads to selling in individual stocks and index-linked exchange-traded funds (ETFs), but fundamentals of the stock itself are intact, as earnings growth is not disrupted. When FIIs withdraw in a big way, the fall can be steep.

It’s better not to panic. Evaluate if the event responsible for a market-wide fall impacts the earnings growth ability of the stock you hold.

If not, then hold on or add more. If you are an ETF investor, evaluate whether the event has a structural impact on the market or a reactionary impact by institutional investors. In case of the latter, hold on or add more.

Investment horizon

Equity is a long-term growth asset, which means you have to remain invested for years at a time to see wealth creation. Sometimes you may have earmarked a specific long-term goal for an equity product. Remain invested despite sharp falls if the goal is still some time away. Buy more if fundamentals remain unchanged.

If the goal is nearing, you can withdraw from equity and put the funds in less volatile investments. In equity investing, prices will move up and down in the short term with events. Over the long term, it is the fundamentals of the underlying stock that matter.

Ready surplus

If the two criteria mentioned above are met, the next step is to evaluate how you can buy more. If you have ready surplus funds, or funds that you don’t need for your contingencies and daily expenses, go ahead and invest more in the market. If not, to invest where prices have fallen, you will either have to sell stocks you hold or sell from allocation to other assets. This may go either ways, on the basis of your overall financial plan.

Risk tolerance

Ultimately, your comfort with buying more will depend on your ability to endure further capital loss. It is always difficult to ascertain how long a correction will last and it is likely that after you buy more in a correction, the markets fall further. This will mean that there could be an immediate capital loss in your portfolio and profits may accrue only over time.

If the fundamentals are intact, it’s more than likely that eventually the investment will result in positive returns. But if you do not have the tolerance to hold capital losses in the portfolio, it is best not to invest more in a correction. You may even want to sell and preserve value, in case the correction is prolonged.

It is unwise to sell or buy just because the market is falling. But if you are risk averse, it is better to sell the falling stocks so you don’t feel burdened by a loss-making portfolio.

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