Navigate the Volatile Market

 How To Navigate the Volatile Market?

 

The stock market can become volatile at times. ( see table: One year journey of Sensex) even the most seasoned equity investors get a bit distracted by all the screaming front-page headlines and running commentaries. Many individual investors also get extremely nervous about the market in the process. Several of them simply decide or would start looking for ways to get out of the stock market altogether to escape the volatility. Many investors believe that this is the perfect strategy to adopt because they believe the best way to tackle volatility is to get out of the market, many of them would immediately stop their further investments; some would start selling their investments even at a loss. Sadly, the whole approach is wrong. Running away from the market is not the best way to tackle a volatile or choppy market. The opposite of it works better. Several studies have proved beyond doubt that the more time you spend in the market the better your chances of tackling volatility and creating long term wealth.

In fact, you can't escape volatility in the market. If you have entered the stock market with a long- term horizon of, say 10 or 15 years, you would face volatility at least a few times in your investing life. The is because the market reacts to every bit of news- both positive and negative- in its own way. A lot depends on its mood; it would rally on the news of a spate of Initial public offerings (IPOs) of companies hitting the market. However, if it is a bit nervous, it would tank hundreds of points on the same news. The blame would be attributed to the adverse impact on liquidity in the market; similarly, it would shake off negative news in a nice mood and react violently to the same news if it is in a foul mood. 

Take a look at any index over a long period, say ten or fifteen years, you would notice that none of them shoot up like an arrow. There would be so many ups and downs that look so tiny at the first glance, but when you click on them you would figure out the they were indeed significant movements at that time. So, the first point to remember is that you can't totally avoid volatility in the stock market.

 

The second point to keep in mind is that volatility is not necessarily a bad thing. For example, imagine a market that is steadily climbing every day. Sooner or later the valuations of every stock would become very expensive future earnings won't justify the premium they command in the market. In such a scenario, it won't make sense to invest in stocks. That is why many investors believe that the market is very efficient and it has its perfect way of finding the right price of every commodity. So, always look at a correction phase in the market positively.

 

Third, want to beat volatility? As said before, don't run away from the market. Yes, you heard it right. It is the only way to beat Volatility. Running away with losses weren’t help your case. Sure you many be planning to get back to the market when it stabilizes, but by that time everyone would be trying to buy stocks and stocks may again become expensive. If so, another correction may be around the corner, What will you do then? Again run away from the market?

Just take a look at the returns offered by equity mutual fund schemes in the last 10 years and you will understand what we are trying to say. Investors in these schemes have weathered many storms such a global economic crisis and other political factors back home. But these investors stuck to their investment plans and today they have every reason to celebrate. (See Table: Equity MF returns in the last 10 years).

Relax and find out the reason

The market has crashed 500 pints in the last two days. Are you feeling really nervous? Before hitting the pause or exit button, just take a deep breath. Next thing to do is to find out the reason behind the fall. For example the fail may have nothing to do with the domestic economy or the performance of the companies listed in the market. It may be because of some development in a remote corner in the world. However, at that time it may look as if the trouble is likely to stay for a while and it may spill over to markets all over the world. However, with the benefit of hindsight, many investors find that these so-called big events didn’t have such a lasting impact on the market and they definitely did not warrant a sell transaction from their side.

The market has climbed over 13 per cent in the last year. However, if you are one of those extra caution investor running away from the market at the first sight of volatility, you wouldn’t be participating in this rally. This is because you wouldn’t have got into the market at the beginning of the rally because nobody we sure about the outcome of the general election. Or if you really bought all the pessimism regarding the success of the new government, you would be still waiting for concrete signals for the growth to pick up before entering the market.

 

Taking Hasty Decision

As a rule, do not take hasty decisions to buy or sell investments in stocks on the basis of temporary movements in the market. Just because the market has fallen 500- points on two consecutive days is not a reason to make a quick exit. Similarly.

 

You should not stay away from the market simply because some people believe that the stock market can’t be a safe place until a total global economic recovery. This is for your own good. Innumerable studies have proven that not with-standing the short-term volatility equity has the potential to deliver over a long period. How various assets have fared however despite this proven record many people lose patience and money because they try to time the market.

Timing the market is trying to follow the age-old formula of buying low and selling high. Of course, you invest in stocks with the idea of buying low and selling high to make profits, but that is not done by getting in and out of the market. It is done by making small, regular investments over a long period of time. This would help you to weather volatility and also bring down your cost of purchase, which further enhances your returns.

 

Hitting the pause Buttton

 

The moment the market enters a volatile or bear phase the immediate reaction of many investors is to hit the pause button on all investments. The general refrain is that we would prefer to wait out until the market stabilizes. Some investors would even quote some famous investment expert or spout the market lingo and say that they are sitting on cash for clear cues from the market. Sadly, these investors are copying someone’s trading strategy. And trading is not the same as investing. Traders look to buy and sell shares frequently and they adopt very short-term strategy to earn a living. This strategy is not meant for long-term investors. Unlike a trader who wants to pocket quick gains, a long-term investor focuses on creating long term wealth to meet his financial goals also, a regular investor doesn’t spend all day tracking market movements looking for every trading opportunity.

When an investor decides to stop his investments in equity, the entire financial planning goes waste. For example, a person has started investing regularly in an equity mutual fund to fund his retirement that is 15 year’s ways. However he suddenly stops investing in equity after five year because the market has entered a bad phase. As you can see this hasty decision beats the entire purpose behind the investment plan. The whole idea behind investing in stocks to fund retirement was because of the potential of equity as an asset class. However, that wouldn’t happen in this case because the person has chosen to stay away from the market.

 

Most often people who abandon their plan mid-away don’t get back to the market at all. This is because they will try to get into the market when everything is hunky-dory and that seldom happens in the market. They would go on indefinitely postponing the investment decision. Some of them get back to the market again after a sharp rise in key indices, and again they would repeat the same mistake of leaving the market immediately because there could be a correction in the market after sharp really.

 

Stopping Systematic Investment Plans

This is an extension of the earlier point, but it needs to be dealt separately because a systematic investment plan is probably the best friend of a mutual fund investor. Systematic investment plan or SIP allows investors to make small, periodic investments in a mutual fund scheme. The idea behind SIP is to invest in equities for the long-term without bothering about the prevailing trends in the market. The method also helps one to average the purchase price over a period of time. However, the efficacy of the strategy is completely lost if investors continue or discontinue the plan depending on the situation in the market.

 

 Investing everything in equity

 Does your portfolio dance wildly to the tune of the stock market? You should check your asset allocation plan ( if you have one) or you should start an asset allocation plan immediately. Simply put, asset allocation plan is the act of spreading your investments across different asset classes, depending on our financial goals and investment horizon. The idea behind the exercise is to ensure that your portfolio is not at the mercy of a particular asset class. For example, if a person has put his entire investment corpus in equity, his investment would be extremely volatile when the market enters a choppy phase. However, if the person has diversified his portfolio across different assets such as bank deposit, company deposit, debt mutual funds, gold, real estate, among others, it won’t be swinging only to the tune of a single asset class. Another plus point of having an asset allocation plan is that periodic review allows you to book profits regularly. For example suppose your portfolio consists of equity (60%), debt (30%) and gold (10%). Now, imagine the stock market fell sharply and you have noticed during your periodic review that your total equity holding was down to 50 %. You have to rebalance the portfolio by selling a part of your debt and gold portfolio to bring your equity holding back to the original level of 60%. This will also ensure that your investments.

 

Betting on small or big Companies

When the market is entering a rough weather it would be good idea to stick to large and reputed companies. This is because smaller companies get unduly punished during market volatility. However, this doesn’t mean that you should stop your SIP in mid or small cap funds. If you have earmarked a small part of your portfolio to mid and small cap stocks, you should continue with your investment even when the market is volatile and the stocks are punished severely. All you have to do is to stick to a mutual fund scheme with a proven long term track record.

 

 Invest in defensive sectors

 

Many investors try to park money in defensive sectors that are immune to the economic activity to a large extent to weather the volatility. This is because these sectors may be catering to an essential service or producing a commodity. And customers may not be able to cut down on the consumption of those services even when they are hard-pressed for money or turned cautious because of the adverse economic scenario. However, abandoning the original investment plan in favor of an extra conservative investment strategy may rob you of a chance to earn extra returns in the long run. This is because defensive stocks often do not match the performance of active stocks over a long period. Sure, they outperform in phases, but may not over a long period.

Invest in Gold?

 

 When everything fails, investors often turn to gold. At least that used to be the conventional wisdom until a few years ago. (Chart: Gold prices in the last five years)However, thanks to the lackluster performance of the yellow metal in the last few years, many investments experts have given thumbs down to gold an investment option or even as a tool to hedge volatility.

However, this is not to say that you have to sell your gold holding immediately. Remember, your reason for investing in gold was to hedge against a gloomy economy. It may still do the duty in times of an overall crisis in the economy.

If you are an ardent believer in the power of gold as a hedging tool, by all means use gold to diversify your portfolio. Investors can use gold ETFs or gold schemes offered by mutual funds to invest gold.

 

You may be missing an opportunity

 Many investors look at rising market with a certain disappointment. They tend to believer that they have lost an opportunity to make money from equity because the market has gone up so high. It is very interesting to note that these investor hardly consider getting into the market when the markets are falling. This is because they are convinced that suddenly the market has become a dangerous place to be in. This is a costly mistake, since they keep on wondering of the right time to enter the market.

Open Account Free and Start SIP

That is why investors should try to make volatility their friend.

Whenever the market gets into bearish phase, investors should try to buy what they thought was expensive in a rising market. In Fact, this is the basic premise on which SIPs operate. If you keep investing via SIP over a long period, you end up buying more units because of the cost of averaging. This is because you end up buying more when the market falls and buy less when the market is rising. The net effect would be averaging of your purchase cost. (See table: Power of regular investments)

 

Make tactical allocation

May successful investors use the volatility in the market to maximise their returns via tactical allocation. They earmark additional fund for this purpose and make purchases in beaten down stocks or sectors. These investments are done without disturbing the original investment plan. Some investors use the fall in the market to accumulate stocks they already own or they wanted to own. Some investors look at sectors that have fallen drastically or are on the brink of a revival. The logic behind such tactical allocation is simple: enhance returns of the overall portfolio by using the volatility in the market.

Invest in overseas stocks

Tired of the volatility in Indian stock markets? Why don’t you invest in overseas funds? You can invest up to Rs. $250,000 every year abroad. And don’t think it is a very difficult process. It is very easy to invest abroad by using the mutual fund route. All you have to do is to invest in an international fund with a proven per romance record. Sure, there are many investment experts who disprove of this strategy. They argue that developed markets are unlikely to match the returns offered by a developing market like India. The argument has some merit. However, diversification across geographical boundaries is not just about maximizing returns. It is also about insulating your portfolio from the vagaries of a single market.

This level of diversification may not be very useful to small investors. However, those with a large portfolio may find it extremely useful.