Late Rakesh Jhunjhunwala once said,
“Market is always commanding, mysterious, uncertain and volatile.”
This quote alone tells us the uncertainty involved in markets and investors, amateurs and veterans alike cannot predict it. While the returns from the markets entice individuals, the risks involved often keep them from investing.
To generate inflation-beating returns and grow wealth, we should think beyond bank/post office savings and deposits. Investors can no longer ignore the higher returns offered by the market, especially during these times of high inflation.
While investors, amateurs and veterans cannot escape volatility, those who effectively manage it and stay invested during the worst times, reap the maximum benefit.
In this blog, we discuss some of the age-old methods used by investors to deal with market volatility.
What is volatility?
In simple terms, volatility is the rate at which the price of an asset changes over time. It refers to both the upward and downward movements in value. The asset can be anything - stocks, bonds, gold, real estate, etc.
If you see higher upswings and downswings in an asset, investing in it becomes too risky. Hence, volatility becomes the risk associated with an asset. The higher the volatility of an asset, the higher the riskiness and the higher the reward or the earning potential.
Like specific assets or industries, the overall stock market also experiences volatility. Markets go up and down all the time.
Source: Yahoo Finance
The above image shows the movement of the BSE Sensex on a single day. It is times of extreme upswings and downswings that create anxiety among investors.
Let us discuss some of the reasons for market-wide volatility.
What causes market volatility?
Political factors - Government policies, tax reforms, regulatory changes, budget proposals, etc. will impact the stock market. Political stability is another important factor that gives a positive outlook to the market. You would have noticed the market behaviour during the Lok Sabha elections. A stable government gives confidence to investors when compared to a coalition government.
Economic factors - The unemployment rate, GDP growth, inflation rate, etc. tend to affect the market performance.
Market behaviour depends on its perception of economic factors. When interest rates are cut down, the stock market responds positively because it reduces the borrowing cost of companies. Hence growth in the economy increases which in turn leads to earnings growth of businesses. Similarly, if there is high inflation in the economy, the markets are expected to react negatively.
Stock markets across the world are interlinked. Any positive or negative eventson an overseas market sends ripples across the world. The recent economic event that affected global stock markets was the collapse of 3 major banks in the USA.
Geopolitical factors - Trade agreements, global conflicts, wars, sanctions, elections, etc. impact the stock market.
Stock markets across the globe faced the brunt of the Russia-Ukraine War. Likewise, elections in the USA have a major impact on all the stock markets.
Note: One should keep in mind, that the stock market performance is a combination of multiple factors because the global stock markets are as linked as ever before. Hence, predicting the market has become very difficult.
Here are some tips to navigate the market volatility
Before diving in let us have the historical chart of BSE Sensex here. We would revisit the chart throughout the next section.
Source:tradingeconomics
Educate yourself and invest with a long-term plan - The first step of investing is understanding the market and its nuances. It helps you to make the most of the opportunities available to you. This would help you understand the risk-return characteristics of various products.
Markets are predictably unpredictable and investing with a long-term vision is the only way to generate positive returns. Think about it, without a long-term plan with timely milestones, you would be like a traveller without a destination.
By using investing knowledge and a long-term plan, you can quantify your milestones.
2. Maintain an adequate emergency fund -
Once you have a clear long-term vision and solid investment plan, make sure there is enough cushion available to minimize the losses. It is a healthy practice to maintain at least 3 to 6 times your monthly expense as an emergency fund. Park this fund in safer instruments like bank deposits, T-Bills or liquid funds. That way, if you require urgent money, you don’t have to sell your assets at a loss when markets have plunged. If you look at the chart above, you wouldn’t want to sell your investments at points A (2008 crisis) or B (COVID-19 crisis).
Also, try to resist the urge to break the emergency fund whenever you find a good opportunity. Because like markets, life is unpredictable. Keep the emergency fund for emergencies.
3. Divert the amount to be used in the near future to less risky assets -
When you start financial planning and investing, you will have a number of life goals to be achieved at particular time intervals. Suppose you are planning to buy a car using your
savings. You are waiting till next year to make the purchase.
Common sense tells you to make some extra money by investing it in the stock market rather than keeping the money in bank FD.
Let me take you to the graph to drive home this point. Imagine, you invested in the market in April 2019 when the market was on an upswing. By April 2020 the market tanked amid the COVID-19 crisis. Only by Oct 2020 could the market recover to the levels of April19.
It should be clear by now that smaller timeframes are not enough to regain any losses made in the markets. Hence, try to stick to safer instruments.
4. Stay Diversified -
Diversification is an age-old mantra of investing. Finance experts have been telling us ‘Don’t put all your eggs in one basket’. This couldn’t be more true during times of volatility. When markets experience extreme upswings and downswings, different assets react to it differently. Certain asset classes, specific sectors within asset classes and certain stocks within a sector can experience higher volatility. Hence, diversification among asset classes, sectors and stocks is important. This helps in capital protection.
This brings us to the next tip.
5. Rebalancing the portfolio -
After securing your portfolio via diversification, one should consider rebalancing the portfolio. Rebalancing helps you to maintain diversification according to your risk level.
Along with generating the required returns, it also helps to manage extreme market volatilities.
During our financial planning, we build a portfolio with the right asset mix to generate the returns we want. But, over time the weights change. Some assets or sectors become overweight and others become underweight. This would be different from your initial plan and hence, the risk of your portfolio also would have changed.
Suppose a particular asset or sector has given you huge returns, investors would not want to partially sell it and bring the portfolio weight to initial because of the better performance. But, you already know this, More the risk, the more the reward. The particular asset that has given you the maximum return would be prone to extreme volatility during market uncertainties.
Source: Wikipedia
The above is the chart of the US NASDAQ index. You would have heard about the dot com bubble. During the period between 1995 to 2000 valuation of tech stocks soared as a result of huge investments in internet-based businesses. NASDAQ gave five times returns during this period. The bubble eventually burst in 2000 and the fall lasted till 2002. Many fundamentally strong companies like Cisco, and Oracle saw their price fall to as low as 80%.
In such a situation, keeping a portfolio which is overweight in tech stocks would have eroded your wealth. To prevent such situations, rebalancing your portfolio should be a habit.
6. Invest through SIPs -
Imagine you have Rs 1 lakh from savings to invest in the stock market. You are looking for the right moment to enter the market. But market veterans would tell you that one cannot time the market. It is so unpredictable. If you are a beginner investor, instead of investing in lumpsum, invest in an SIP.
SIP is investing a fixed amount of money at fixed time intervals. You buy more units when markets are low and buy fewer units when the market is on an upswing. It averages out the cost of a particular share or security. This strategy is called dollar cost averaging. If you stick to this strategy for the long term, you will reap good returns. This is a strategy particularly helpful for beginner investors.
7. Get professional help -
If you are someone who doesn’t have the time to do all the above things, you should consider professional help for managing your money. Or if you have created a large corpus, then leaving it to experts is better than individually managing it.
Another important point to consider is that stock market cycles have become a lot shorter than the older days. That means bull markets turn to bear markets and vice versa in a matter of months. You have to be very cautious with diversification and portfolio rebalancing. Professional help would be handy when things move at a really fast pace.
Finally, let us part with a quote by Warren Buffet
“The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is free to either ignore the market or exploit its folly.”