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Smart strategies for unpredictable markets
Hemant Rustagi, Moneycontrol.com | May 19, 2006
The moment equity markets turn volatile, it causes anxiety and in some cases, even sleepless nights. No wonder, many investors abandon a carefully designed investment strategy in a knee-jerk reaction and pay the price for it. Obviously, it is not a smart thing to do.
The key is to recognise that volatility exists in the market place and will remain so. After all, volatility is a statistical measure of the tendency of the markets to rise and fall.
While volatility can be described as a natural phenomenon, there is a need for investors to develop ways to deal with it. In reality, different people react differently to market volatility. While a seasoned investor may take volatility in his stride, a novice investor will be tempted to pull out of the market completely.
Someone who has spent time in the stock market would know that it is quite normal for the stock market to go up and down in certain time periods.
For those who are not familiar with equity markets, it is important to put volatility in perspective. The fact of the matter is that irrespective of the instrument that you invest in, you still have to contend with volatility. Even if you are a conservative investor and have been investing in traditional instruments, you still have to tackle interest rate fluctuations.
As mentioned earlier, all of us need to develop ways to deal with volatility. Let us analyze various strategies for both existing, as well as new investors to handle volatility.
Strategies For Existing Investors:
In a volatile market, an existing investor might be tempted to think that the best course of action would be to try and anticipate the market movements and move his investments accordingly. It is a proven fact that even experts find it difficult to achieve this.
Therefore, the best way is a market timing and adopt a disciplined approach to equity investing.
For those who invest through a well-defined financial plan, the best way to handle volatility is to stay away from it altogether. In other words, the best option for such investors would be to ignore short-term volatility. The main advantage of remaining invested is that one minimizes one's chances of missing out on the sudden rallies in the market.
In a frequently volatile market, it helps to diversify. Diversification not only reduces risk but also helps in optimizing returns on a risk-adjusted basis. For those investing in equity directly, mutual funds can help achieve the level of diversification not possible to achieve through direct investment in equities alone.
For those who are already invested in mutual funds, it is necessary to make sure that your funds from different fund families do not hold the same stocks. If they do, it will have impact on the level of diversification that you achieve through them. Also a heavy concentration in a specific category of funds, sectors, segment and a particular fund house.
Another important strategy is to rebalance your portfolio periodically. Rebalancing is a disciplined method of maintaining proper allocation to each asset class in your portfolio. Over a period of time, the mix of assets in your portfolio may become inconsistent with your original asset allocation. Rebalancing the portfolio in a planned manner makes your portfolio less prone to volatility.
Strategies For New Investors:
First of all, it is important for a new investor to understand that market volatility is quite normal. However, volatility is an unpleasant realty of the marketplace that deters most investors from investing in the stock market. Fortunately, there are strategies, if followed properly that can help in more than one ways.
One such strategy is to invest on a regular basis. Mutual funds offer Systematic Investment Plan (SIP). SIP means making periodic investments of the same amount of money in an equity fund regardless whether the stock market is declining or ascending. The idea behind this strategy is that by investing the same amount each month over a period of time, you do not have to worry about right time or the wrong time to invest.
Besides, this cuts down on the risk that you normally face when you end up investing a lump sum amount at market highs, as it is very difficult to predict the movement of the market in the short-term. In other words, SIP can be a good way to protect yourself from a volatile market.
Another recommended strategy is to diversify. For a new investor, it is important to know that even when the market as a whole rises or falls, not every scrip in the portfolio follows suit. In other words, by diversifying within an asset class, you become less vulnerable to volatility in a particular sector or a segment.
The best way to achieve this is by investing through mutual funds. The best thing about mutual funds is that not only are they diversified by nature, they also make it possible to diversify across different types of funds. It is also important to have a long-term investment horizon to handle volatility.
Remember the longer your time horizon, the less your risk. Therefore, if you do not need the money, you can wait for the markets to recover. At the same time, becoming overly optimistic when the markets are good can be as detrimental as worrying too much during the bad times.
Therefore, it will not be wrong to say that the right approach to handle all kinds of markets, especially a volatile one, is to remain focused on your investment plan and objectives.
The author is CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at firstname.lastname@example.org
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