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Volatile markets: Tips to safe investment
February 11, 2008
After over four years of unbridled surge, the Indian stock markets went through a period of sharp correction in the last few weeks. Of course, everyone loves a great ride, but even a small correction drives them to predict the worst. While the correction was not unexpected, the steepness would have caused a lot of heartburn among stock and mutual fund investors.
The plunge of over 4,000 points has left investors wondering if this is the beginning of a bear market or just a knee jerk reaction to the recession fears in the US economy.
As is evident from the last few weeks, there is high volatility that would have shaken the confidence of even the hard core investors. But they should remember that it is a common phenomenon.
However, it is often noticed that while everyone is happy with a booming market, any downtrend leads to panic. Also, while a seasoned investor may take volatility in his stride, a new investor always has the fear of losing their initial investment and tempted to pull out of the market completely.
It is better if you start with the basic dictum that both over enthusiasm and panic are traits that should be best avoided while investing in the markets.
Remember that even the most conservative of investors have to contend with volatility. For example, someone investing in even traditional instruments has to tackle interest rate fluctuations.
However, it is always easier for a long-term investor to handle volatility compared to a short-term investor who may find it difficult to cope with it. The longer the time horizon, the lesser the risk. Therefore, if you do not need the money, you can wait for the markets to recover. For those who invest through a well-defined financial plan, the best way to handle volatility is to ignore it altogether.
In a frequently volatile market, diversification can be a great tool. By diversifying, one can not only reduce risk but also optimise returns on a risk adjusted basis. For those investing in equity directly, mutual funds can help achieve a level of diversification that is not possible to achieve through direct investment in equities alone.
For existing mutual fund investors, it is necessary to make sure that schemes from different fund families do not hold the same stocks. If they do, it will have an impact on the level of diversification provided by the portfolio. Also one needs to avoid heavy concentration in a specific category of funds, sector, segment and a particular fund house.
Another strategy to tackle volatility in the market is by investing on a regular basis through systematic investment plans. SIP means making periodic investments of the same amount of money in an equity fund, regardless of 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 the timing. Besides, this cuts down on the risk that you normally face when you end up investing a lumpsum amount when the market is too high. In other words, SIP can protect your in a volatile market.
It is often said that 90 per cent of investment success depends on the quality of the portfolio and the right mix of funds investing in different market caps and the remaining 10 per cent on timing the investments.
In reality, many investors spend 90 per cent of their time "timing" their investments. As a result, they panic. Success in the stock market game, whether through stocks or mutual funds, hinges on one single factor.
Buy good stocks and funds and, then forget them. Returns will always come.The writer is CEO, Wiseinvest Advisors