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Business News/ Money / Personal Finance/  A 3-step plan to thrive in a falling equity market

A 3-step plan to thrive in a falling equity market

The challenge comes from the psychological mind games a falling market plays on you

Photo: iStockPremium
Photo: iStock

Indian equity markets are down 10-15% over the last few months. Will they fall further? Unfortunately, historical evidence shows that it is impossible to consistently predict short- term market movements. So, how do we deal with this dilemma? Here is where you can use the ‘preparation approach’ vs the ‘prediction approach’.

The preparation approach consists of 3 steps: 

Understanding historical odds of temporary market falls: The last 42+ years history of the Sensex shows that Indian equity markets experience a 10-20% temporary fall almost every year. There were only three of the 42 years when the intra-year fall was less than 10%. When viewed from a historical lens, the recent fall is perfectly normal and nothing to be surprised about. Larger temporary falls of 30-60% are less frequent and usually occur once every 7-10 years. We must learn to accept and endure 10-20% temporary falls every year and a 30-60% fall once every 7-10 years. A temporary decline should not be viewed as a ‘fine’ to be avoided but rather as an ‘emotional fee’ that must be paid for long-term equity returns. 

Pre-loaded decision plan to increase equity exposure during a fall: History shows that despite several crisis, Indian markets have always recovered and gone up over the long run (mirroring earnings growth). You can use this to your advantage to deploy more into equities during a sharp market decline. 

This can be done via a crisis plan where you pre-decide a portion of your debt allocation or new money (say Y) to be deployed into equities on market correction. For example, if the market falls by 20%, then move 20% of Y into equities, if the market falls by 30%, move 30% of Y into equities, if the market falls by 40%, move 40% of Y into equities, and if the market falls by 50%, then move the remaining portion from Y into equities. You can customize this plan to your needs.

Managing your emotions during an equity market fall: Having a pre-loaded plan doesn’t mean executing it will be easy. The real challenge comes from the psychological mind games that a falling market plays on you in phases.  It all starts when the markets are initially down by 15-20%. 

Phase 1—The worry phase:  What if the markets fall further?  What if there is extrapolation of current bad news or  experts warn that the worst is yet to come?  What if everyone seems to be selling and you are worried that you are wrong?  What if your personal circumstances worsen—job loss, pay cut, health issues, etc? 

Phase 2—Act before it’s too late: There will be pressure to take quick decisions when your portfolio is going down every day. There will be an urge to exit and avoid further damage and you think you can enter back at lower levels. 

Phase 3—Resistance: Here is where you overcome your panic, remind yourself that no one can time the markets and that  enduring a market fall is an emotional fee to be paid for long-term equity returns, and finally stick to your plan and belief. 

Phase 4—Oops! The market falls further by 5-10%. 

Phase 5—‘I Knew It All Along’: In hindsight, it will seem obvious that this fall was coming—the red flags were everywhere and this fall could have been predicted. In fact, you had predicted this a few weeks back. You will ignore all periods where there were red flags but the markets didn’t fall This is commonly referred to as ‘Hindsight Bias’ or the ‘I-Knew-It-All-Along’ syndrome 

Phase 6—Regret: This phase in a falling market is where your intuition comes right in the short term. You regret not having listened to your intuition—‘If only I had sold earlier…’ 

Phase 7—Frustration: In this phase, initially, you will find your portfolio returns fall below that offered by fixed deposits (FDs). Then all your positive gains vanish and your portfolio value is now lower than the amount invested. A few months have wiped out several years of your portfolio gains  and even your SIP (systematic investment plan) returns are dismal. 

Phase 8—Doubting phase: This is the phase where you start doubting your plan. Should you still believe in equities? What if this plan is not working anymore?  What if this time it’s different? 

This is followed by the first phase again and the cycle repeats with every incremental 5-10% fall till you finally panic and exit equities. No wonder then that falling markets are the ultimate behavioural test for investors.  Overall, these are the three steps that can help you take advantage of a falling market but as the saying goes—it’s simple but not easy. 

Arun Kumar is head of research at FundsIndia.

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Published: 26 Jul 2022, 10:59 PM IST
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