4 mistakes to avoid in a market crash4 min read . Updated: 26 Sep 2011, 10:20 PM IST
4 mistakes to avoid in a market crash
4 mistakes to avoid in a market crash
There is no denying that western countries are in the midst of a serious financial crisis, the effects of which are being felt in our capital markets too: domestic equity market crashed 4.1% last Thursday. While the fall was in line with how equity markets performed in other developed and emerging economies, the fact is that in two months Indian equity markets have corrected more than 14%. The other reality is extreme volatility—the correction has happened in sharp jerks over a few days.
Don’t panic and sell equity or mutual fund units or stop your systematic investment plans: The foremost thing to do is not panic. On a day when you see that a number of indices across the globe have corrected at least 3%, some up to 7-8%, its only natural that panic sets in and you assume the worst. Undeniably, the economic growth, specifically in developed economies, is slowing and this is causing jitters in financial markets. But there is another side to the story.
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Let’s look at the financial market chaos three years ago. Although the premise was different, there was a liquidity freeze and equity markets world over literally went into a free fall. The S&P Nifty corrected 21.3% in nine months. Calculations show (see graph) that you would have earned less if you had stopped your systematic investment plans or SIPs after August or September 2008 (when the markets started to fall) and then restarted only after May 2009 (when the markets started to recover), rather than just continuing or topping up your SIP through the nine months as the markets fell.
A number of large brokerages now have the facility of SIPs for direct equity investments too. So you can choose the stocks you want to invest in and build a customized portfolio. Money can be invested in part on a systematic basis every month or at any other frequency defined by you.
Don’t block all your money in fixed tenor products like fixed deposits and bonds: Investing in financial assets requires a kind of discipline. It makes sense to buy when prices are low and sell when high. However, very often investor sentiment is at the lowest when stock prices are correcting and there is positive euphoria when market touches all-time highs. Don’t get carried away by sentiment and use market corrections to realign your asset allocation and add more equity. The correction may have already lowered the absolute value.
You may be tempted to choose safe havens such as fixed deposits and long-term bonds, thinking that returns are high. Current high interest rates have created many attractive opportunities in fixed-income products. But investing in those should not be at the cost of your overall asset allocation. Says Suresh Sadagopan, a Mumbai-based financial planner, “Fixed deposits should be invested in as per your individual diversification needs. Today, equity values are lower as compared with a year ago and ideally allocation to that can be increased by buying at dips."
You can have some money allocated to fixed-income products, but it is also useful to have liquidity to take advantage of equity market corrections. So, even at high rates, its not prudent to have all or most of your funds in fixed-income products with a fixed tenor.
Don’t shy away from equity. Markets overreact on news and turnaround sooner or later but you need to have discipline and liquidity to take advantage of corrections.
Don’t make hasty purchases: When markets correct by large amounts, stock prices start looking very attractive. Out of 200 stocks in the S&P CNX 200, 48 stocks have corrected more than 20% since 25 July. Similarly, in the S&P Nifty, 31 stocks have corrected more than 10% in the same period. This doesn’t mean you should rush to buy the stock that has corrected the most, hoping that the subsequent rise in price will be maximum too.
Usually, such corrections weed out the bad from the universe, which simply means that when markets recover, it is the quality stocks or companies that gain the most and sooner than others.
Says Mahajan, “What is looking cheap (on valuations) now, may look expensive tomorrow. Investors should use market volatility to accumulate quality stocks. Going forward, in a couple of years a quality portfolio can deliver 20-25% return."
So it helps to keep things simple and stick to large-cap stocks that are backed by quality earnings and management expertise. Similarly, select your mutual funds carefully; stick to the tried and tested top performing funds.
Cut out the noise: When you see a 4% correction over a single trading session, of course you will want to know what happened and why and what is going to happen the next day. Avoid seeking too much information on flash events. Usually, such events are followed by a barrage of expert opinion and that may confuse or scare you more than anything else.
Listening to too many opinions will cloud your own judgement. You may get trapped into believing that market movement can be timed and you want to wait for the right time (bottom fishing) to invest. Says Sadagopan, “The best option for long-term investors is to stay put. Predicting dips is difficult, so stick to an asset allocation and avoid taking a wrong call." As long as you are sure of the bigger picture and the long-term growth story remains in place, keep investing systematically. Disciplined asset allocation and investing via systematic transfer plans and SIPs can help tide over short-term volatility.
Investing in times of extreme uncertainty is not easy, but time and experience has taught a lesson: by applying discipline and common sense it is possible to earn suitable returns in the long term.