Should the Market Determine Your Asset Allocation?

The ups and downs of the financial markets are always in the news. The market can plunge (or shoot up) at any time. A natural reaction to the fear of markets moving opposite your expectation might be to reduce or eliminate any exposure to the stocks and securities, thinking it will cut out further losses. It is natural to feel discouraged when market does not perform well. However, you overlook the fact that the markets may eventually improve and you could be in a position to benefit when this happens. A popular maxim springs to mind here 'what goes up will come down', let's face it - Markets will fluctuate. It's a natural phenomenon. However, it is generally advised that investors should not panic to such market chaos and not fall prey to greed.

Does this mean that we should be extra cautious towards the securities markets and invest less or not at all?

No, equities are more of a long term investment option, since generally equities as an asset class is expected to give good returns over a long period of time.

Or investors could go the other way of investing, with the intention of redeeming or profit booking when the markets improve. Your profit making ability will depend on the ability to judge exactly when the market starts rising (or falling). Unless you are a financial wizard, this is likely to be very difficult to get it right every single time.

Irrespective of which type of investor you are, should you panic every time there are any sharp market movements?

It is important to understand the difference between volatility and risk. Volatility in the financial markets is seen as extreme and rapid price swings. Risk is the possibility of losing some or all of an investment. In a volatile market there is a risk of loss, as the market may swing from peaks to troughs. Market volatility should be a reminder for you to review your investments regularly and make sure you have an investment strategy with exposure to different asset classes.

As far as your investments are concerned, while the falling values in equity may make you uncomfortable, it is always better to spread your investments across asset classes between equity, fixed income and gold.

Some strategies for investors in volatile market conditions:

Go long-term:

Investors should invest with a long-term outlook in fundamentally good stocks only. Patience is the key in volatile market conditions. It is possible that the security you buy may fall further, but you should not panic and start selling that security in the market. When you invest in the securities market, you are investing in companies. And companies take time to grow. Hence, you should ideally have a horizon of at least 5 years or more for your investments.

Set targets:

In volatile market conditions, smart investors do not panic. They buy when everyone else is selling and sell when everyone else is buying. Keep a buy and sell price in mind, E.g You decide that you will invest in XYZ stock only if the price is Rs. 10 or lower and sell if it is Rs. 20 or higher.
Maintain that discipline in your investments and buy and sell at the decided values, don’t allow greed to make that extra money to overrule sound judgment.

Do not try to time the market:

Attempting to move in and out of the market can be costly, particularly because a significant portion of the market’s gains over time have tended to come in intense periods. Many of the best periods to invest in stocks have been those environments that were among the most upsetting periods. Investors face long odds in trying to time the ups and downs of the market and it may happen that they increase their allocations to stocks ahead of downturns and decrease their exposure just prior to market rallies.

Invest regularly and see the power of compounding:

If you invest regularly over months, years and decades, you can actually benefit from a volatile market. Through a time-proven investment technique called rupee cost averaging, you invest a set amount every week, month, or quarter, regardless of how the market is doing. Under this system, one need not worry about when and how much to invest. A fixed sum of money can be invested regularly. Compounding is the ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings. Starting a Systematic Investment Plan (SIP) will help you harness the power of compounding as you invest a set amount every day/week/month etc irrespective of the wild swings of the market.

*The numbers used in the table above are for illustrative purposes only

Remember to Diversify:

Your focus should be on diversifying your portfolio to protect yourself from market volatility. Products such as ETFs, low-cost mutual funds etc. fit the bill. All this will keep your portfolio primed for the time when the market reverts to the growth mode. Diversification of investments helps to manage overall portfolio risk.

Therefore, it is advised not to lose your nerve during a market fluctuation. Being patient works during a market plunge. Just like the fabled tortoise that beats the hare in the race, the investor who stays in for the long term is more likely to achieve his or her goals than the investor who chases “hot tips” for quick profits in the stock market.