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How to Invest during Extreme Markets
Anyone who has invested in markets long enough will tell you that like seasons, markets too typically move in cycles. It may have periods of brisk ups and downs or lateral, flat movements. So how do you cope when the market is extremely volatile? Rapid swings in the market make you most susceptible to big losses or gains. There is often a marked increase in the frequency of trades during such times and markets seem hyper sensitive to any event or news.
So, what should be your investment strategy during such a period? Let’s find out.
Common Investor Behaviour during Extreme Markets
Although durations vary, a low phase in the market is followed by a high phase and so on. Inspite of an overall knowledge of market movements, many investors panic in the low or bear phase and become excited during bull runs. They end up buying when the market is high and selling when it is low, to make a quick profit or stop losses. It is exactly the opposite of what they should be doing.
One has to remember that equities are a volatile asset class. However, volatility reduces as holding period increases, good times and bad times, typically follow each other. You can rise over extreme markets smoothly by following these 5 golden investment rules.
Be patient.
Remember that returns from equities help create wealth over the long-term. Instead of chasing quick returns or stopping losses overnight, it is always beneficial to stick to a steady investment strategy. Short-term volatility won’t matter much if you are taking advantage of ups and downs in the market by regularly investing systematically. It is important to keep investing regularly, irrespective of market levels.
Don't take decisions based on emotions.
Investors generally get swayed by emotions rather than economic sense during this period. They invest more in good times when valuations are rich (high PE) and refrain in bad times when valuations are cheap/reasonable (low PE). This leads to unsatisfactory returns. A side-effect of this experience, when panic leads to a sell-off or euphoria leads to blind investing, is that investors stay away from markets in the future. One has to remember that markets move in cycles and eventually get corrected.
Look for good investment opportunities.
Extreme markets can be a good time to let go of lemons in the bull run, as in investments that have given you consistently low returns. During the peak of a bull run, very few companies trade below their actual value. This makes it a good time to prune your bad investments. Conversely, when markets are at an all-time low, there may be good pickings on the offer. On investments made in bad times (where PE<15), typically returns over the next 3 years or more are better due to earnings growth and improvement in valuation.
For example, let’s take a case of two friends Tarun and Ajay. Tarun invested in March 2008, when markets where high, whereas Ajay invested a year later, in March 2009. However, by that time the market had crashed and was at an all-time low of previous 2 years. Assuming the BSE Sensex was their benchmark, let’s see how their investments fared in the next three years.
If you see the historical BSE data, investments made in March 2008, when Sensex was at a high of 15644 points, gave a return of just 4% over the 3 year period. In the other case, investments made in March 2009, when BSE had tanked to 9709 points gave a return of 18% over the 3 year period. Hence, it would be safe to assume that Ajay’s returns were more than four times than that of Tarun’s. It shows that good investments made during bad times have a much greater potential to give higher returns as compared to investments done at the peak of markets.
Rebalance your portfolio.
If you have the time and the expertise of investing in markets, you can derive benefits by keeping a check on your investments and rebalancing your portfolio. A seasoned investor can also consider balanced funds as they move investments from equity to debt, every time the market breaches a level.
Rely on professionals.
You may agree with any sound investment advice in normal circumstances but in an overheated market, it is very difficult to keep a rational approach. On top of that, many of your friends and relatives, who may have also invested in the markets, will have ‘hot tips’, tempting you to take a break from regular investing to make a quick profit or stop losses. Extreme markets require a lot of patience and deep knowledge to enable any investor to pick a good option or know when to let go of bad investments. If you don’t have the expertise, it is always better to rely on professional money managers with a sound track record. Mutual funds also provide a good investment option as you can enjoy lower risk with the benefit of diversification by investing in equity diversified funds.
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Remember equities are a volatile class. Returns from equity investments are a function of earnings growth and changes in valuation.
If already invested in an equity diversified mutual fund, don’t panic. Continue with your SIPs inspite of the short-term fall in the investment value.
For the experienced investor, rebalancing portfolios leads to higher potential returns as compared to stop loss mechanisms to contain losses.
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