Staying invested for a longer ‘time’ becomes the best strategy to achieve long-term success in the equity markets
Returns in the equity markets are nonlinear. While the shorter runs are generally marked by more volatile roller coaster rides, the probability of achieving inflation-beating returns increases in line with the holding period, and becomes attractively high in the longer runs. As the effect of compounding becomes visible only in the longer run, equity investments hold the potential to fulfil investor's long-term goals if they are given sufficient time. However, it is always difficult to predict the short-term direction of the market, making the task of ‘timing the market’ a daunting one. Hence, instead of ‘timing the market’, staying invested for a longer ‘time’ becomes the best strategy to achieve long-term success in the equity markets. Indeed, ‘Time in the market’ takes precedence over ‘Timing the market’.
It is also imperative for investors to fully comprehend the nature of up-down gyrations of the stock prices, which generally follow the market cycles. The market moving up for a sustained period is known as the ‘bull phase’ which is generally driven by a positive optimism on economic growth. During such a phase, the investors’ risk appetite runs very high. On the other hand, a declining market over a sustained time is known as the ‘bear phase’ of the market. This generally signifies the phase of economic slowdown and overall negative sentiment towards its futures prospects, leading to a lower risk appetite. Historically, NIFTY has seen a total of 10 bull phases since 1992, in which the average bull-phase return stood at 144 per cent with an average period of 27 months, while the average correction in nine bear phases was 36 per cent, with an average contraction period of 12 months.
What exactly is the stock market crash?
A crash is a sharp fall in the stock market prices either in a day or over a week. This sudden fall in the market may be triggered by a perception of weak economic growth or the investors’ negative emotion of fear of loss. In 2020, global equity markets, including the Indian market, witnessed such a crash as the outbreak of the Covid-19 pandemic, clouded by serious concerns over the global economic health and its growth.
Investment strategies to sail smoothly through the stock market crash
Invest systematically and focus on the long term
No one can predict the timing of the market crash or the period of the bull phase. These bull and bear phases are driven by investor sentiments. While the positive sentiments will yield an upward moving market, the fear scenario will result in a falling market. To mitigate the risk of wrong market timing, investing systematically over some time rather than in one tranche is recommended.
Well-defined investment goals
Risk calibration plays a key role in long-term wealth creation and its process can be started by clearly defining goals and categorising them into short-term vs. long-term goals. This should be followed by setting up the right mix of asset classes to achieve predefined goals based on the investor’s risk profile. During the crash, it is recommended that you don’t deviate from your long-term investment goals. By following a disciplined approach, one can sail through the short-term volatility and achieve his long-term investment goals.
With volatility being an underlying risk associated with the individual asset class, asset allocation becomes a crucially important step while managing personal finance. 2020 marked a highly volatile time, witnessing multiple ups and downs in asset prices amidst acute uncertainties led by the advent of the pandemic. By achieving an optimum diversification of savings into various asset classes, coupled with proper risk calibration, one can successfully sail through such volatile times. With a right and diversified asset allocation, one can manage the portfolio drawdown in the case of sudden events such as market crash and smoothly survive the volatile time vis-a-vis. an investment portfolio comprising only the equity class.
Clean the portfolio regularly
Every bull phase of the market provides the investor with an opportunity to correct the mistakes made in the last bear phase. In a bull phase, low fear of loss generally leads to momentum even in the low-quality stocks, tempting investors to create higher holdings and consequently higher exposure to the low-quality stocks. Once the cycle turns, less weightage to high-quality stocks in the portfolio results in substantial losses. Against this backdrop, it is recommended to consistently focus on creating and maintaining a high-quality portfolio with profit booking and/or a well-defined exit strategy to clean the low-quality stocks from the portfolio once the targeted returns are achieved.
Invest in the liquid stocks
As fewer liquid stocks tend to fall more than the liquid ones when the tide turns from bull to bear market, it is recommended to build larger positions in more liquid stocks. Conversely, it is imperative to have a proper exit strategy while investing in less liquid stocks.
The most important strategy in events such as market crashes is not to panic. With the intensity of negatives news flow and pessimism increasing with every fall during these times, one needs to keep their emotions under check and refrain from panic selling. As long as the portfolio is diversified and has the right mix of quality stocks, one can sail through the volatile time smoothly without succumbing to panic-driven mistakes.
Capitalise on opportunities when others are selling
Significant panic selling during the market crash provides patient investors ample opportunities to build positions in high-quality stocks at cheaper and attractive prices. Keeping this in view, it is highly recommended to always maintain liquidity of 5-10 per cent to grab such opportunities.
Maintain liquidity in the emergency funds
An emergency fund is a corpus intended to protect an investor from uncertain and unfavourable events such as untimely job loss or medical emergencies. Ideally, one should keep 6-12 months of monthly expenditure as an emergency fund to protect against any unforeseen and adverse events. Making adequate emergency funds will critically help an investor sustain times of crash and fulfil his emergency demands without being forced to sell his equities at lower prices and incur a permanent loss of capital.
The author is Head – Quantitative Equity Research, Axis Securities
DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.