Treat stock market falls like discounts. SIP on every dip

When markets crash it is indeed time to be cautious. But here's why and how buying makes sense at such times.

Sale! Upto 50 per cent! shouts a hoarding, and we gear ourselves to make the best of the shopping season. We are elated and plan our weekends around the best deal in town. Be it any part of the world, most discounts and offers on goods attract similar behaviour in people. 

Why not? Who doesn't like a good deal. But if this is true, why do most of us behave in exactly the opposite manner where the stock markets are concerned? When the BSE Sensex – the benchmark that is representative of the broader stock market performance -- dives down, and blue chips sell at really cheap rates, we exit our market-related investments and flock to safe and guaranteed returns.

The swing in the market and the uncertainty associated with the stocks push us away from capital markets. We become pessimistic and reject the idea of investing in mutual funds or any product that doesn't provide fixed return. Perhaps, this may be because the world of finance is much more complicated than buying a dress or a piece of furniture.

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A bad business cycle or a poor macroeconomic scenario results in a sustained period of nervousness in the markets. But even so, underperforming markets offer us the chance to buy the largest and most stable companies at a bargain.

Thus, if we follow the same logic of discount, we should take the market fall as an opportunity to buy the best-valued companies. All you need is surplus money that will not be needed immediately, and the patience to wait for the markets to recover and your discount stock to peak to its full valuation. History shows us that markets eventually recover and scale up to the next high, although only after a significant period of time.

For instance, the Sensex had a sharp fall in June 2004, when BJP lost unexpectedly in the general elections and it became evident that the communists in India will influence governance and policy. After three years, the total return was 204 per cent while the five-year absolute returns was 212 per cent.

Yes! The answer may surprise those of us who have burnt their fingers in the past. It doesn't mean we put all our hard earned money into equities. What we recommend is allocating a small part of savings into mutual funds as a form of diversification, apart from our regular investments in fixed deposits and small savings schemes.

In the chart shown alongside, we can see the common investment mistake is to enter the markets at their peaks, when everyone is euphoric, everyone makes money and everyone offers investment tips! In this way, people end up investing when the markets are at a premium and not on sale.

Also, when the general sentiment is at lowest, people sell off their equity portfolio, causing a loss on their hard-earned savings. Investor sentiments graduate from optimism to euphoria as the markets inch higher towards all-time highs, as witnessed in the previous bull runs of 1990s, the dot-com era of 2000 and the recent 2008 phase. Often, once the markets have risen, we buy the same blue chip shares at a higher price, after selling them low when the market fell.

This emotional decision making at market peaks and bottoms often leads us to make the most mistakes with our portfolios.

In life, we face several ups and downs, and learn that we shouldn't get too hassled when things go wrong or get overly confident or lax when everything is rosy. Markets too move in cycles, so we need to apply the same mantra to our equity investments. The trick is selecting sound, valuable stock, and not letting temporarily unsettling movements unnerve us.

Think equity, start SIP

Of course, selecting a product or a stock to invest in is tough. First of all, how can you be sure that the company stock that you are buying will grow five times in next 10 years? What can be a company's earnings potential, and whether there are other investments which might give a better return?

If you are sure that the company's future earnings potential is good, you can invest in it. Infosys is one of the IT companies that created wealth for investors after a humble start in 1981. But, not all companies become Infosys.

A simple way to invest is to start a systematic investment plan (SIP) of an equity mutual fund, which is like starting a recurring deposit into a bouquet of companies. Mutual funds have professional managers who track and evaluate companies on a daily basis. One can start with an amount as low as Rs 500 for an SIP and Rs 5,000 for a one-time investment.

Alternatively, you can put some money into an Index fund, which represents the top companies in India in terms of size and investor participation on broad indices such as Sensex or Nifty.

As you plan for your family's future for retirement purpose or to fund our child's education after 10 to 15 years, we can allocate a part of our savings into equity mutual funds. Across a long-term period, the cumulative return from equity is better than deposits. Just like chutney or pickle which adds flavour to our palate, we can add some 'equity tadka' to our investment portfolio.

Finally, be patient with yourself and review your investments to:

• Assess product features and charges, underlying fundamentals, and performance
• Gauge how the possible loss on the investment will affect you, and
• Have realistic return expectations