Opinion | Money lessons from the financial crisis for SIP investors in India
It is for the new investor, who hasn’t seen a deep crash, that the lessons are most important
It is scary to see your life’s investment shave half its value in a free fall in stock prices. Indian stock market investors saw such an episode starting January 2008. If you had ₹1 crore in an index fund linked to the Sensex as on 9 January 2008, by 9 March 2009, its value was down to just under ₹41 lakh. It is gut wrenching no matter how strong your stomach for risk is. The whole time over the year you were driven by sheer panic to sell as the signals about an imminent global financial crisis caused markets to teeter on the edge and periodically belch out another giant fall in stock prices. Some brave hearts held on to their investments during the bloodbath, married as they were to “long-term” investing. By 4 November 2010, they saw their money recover as the Sensex regained its 2008 peak. The market since has given an 8% average annual return. Who are the people who came out on top and what did they do right? A decade, and nearly another 20,000 points on the Sensex later, there are three lessons that we, as retail investors, can draw from the North Atlantic Financial Crisis that had a trigger point when the $639 billion multinational behemoth Lehman Brothers went bankrupt on 15 September 2008.
One, markets go up and down. Stock markets are volatile in the short term and periodically they get into bubble territory. The biggest lesson we need to take from the financial crisis is that stock markets will finally react to the underlying economic signals and will recover if there is an economic recovery. Households typically buy when markets are high and sell when markets crash. What the 2008 crisis and the behaviour of the market post that showed is this: if you have the right products, holding on is a better strategy than panic selling. When markets recover after a crash, they recover sharply and unless you are a trader in the market, you are most likely to miss the recovery. Unless you are invested, you will not be able to gain from the market recovery. The key is to be holding a well-diversified portfolio rather than just a few stocks. Lehman lesson for us is to stay with our investments with the caveat that the investments should be sensible in the first place.
Two, diversification is not just a word. Somebody who was invested in stocks in the financial sector, specially of the firms that went bankrupt, lost all her money forever. There is no recovery if the firm goes bankrupt and stock price falls to zero. The financial crisis brought home the point that your assets need to be spread over different asset classes (equity, debt, real assets), and within an asset class, across different classification of products. For example, an equity portfolio with just small- and mid-cap funds, or an equity portfolio with a larger holding of sector funds that went down would have a very different impact on the portfolio than a holding that has an allocation across categories. As investors we tend to talk about our stock market winners, but that is dangerous territory because winners can become losers. Lehman lesson for us is to look at portfolio return rather than individual stocks performance.
Three, rebalancing has a purpose. A soaring market makes the most risk-averse person begin to love taking risks. The words asset allocation have a meaning. They mean that you choose a combination of debt and equity that makes you comfortable. Your allocation should reflect the distance of your goals from today. The closer you are to your goal, the lower the percentage of equity in your portfolio. If you began with an asset allocation of 60:40 of equity and debt and rising markets cause this to move to 70:30, or even higher, it is time to go back to your original allocation by redeeming equity and buying more debt funds. Rebalancing according to a strategy also allows you to book profits and reallocate them. Lehman lesson for us is to bite the bullet and sell the soaring asset class if the rising prices have changed our original asset allocation.
Indian SIPs are now pulling in more than ₹7,658 crore a month, that is almost ₹1 trillion a year. This is the saving of Indian households who are moving away from real assets, bank deposits and life insurance products to the more efficient and transparent mutual fund product. Much of this SIP book has been built in the past three years. The new investor has not seen a long and deep market crash. It is for that investor that the lessons of Lehman are the most important. If you have begun to invest looking at the past few years’ returns and don’t have a plan in place you will panic and sell at the first whiff of a longer market crack. Panic selling and greed-based buying will cost you. It will cost you money and trust in the markets.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
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