Dealing with Stock Market Collapses

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“Today was the worst decline since the February decline you don’t remember anymore!”

 It’s human nature to get emotional about your money when you are in the middle of a Stock market collapse – and see your holding values shrinking in large measure each day. But one way to counter fear is with faith — in this case, faith that things will eventually calm down and that when they do, you’ll be well positioned to succeed.

We present below some “commandments” to follow in the midst of Stock market volatility to maintain your sanity and preserve your portfolio for the long run. Instead of panicking at the worst possible time and then looking back 10 years from now and asking “What If I had….”, following these commandments may help!

Commandment 1 : Thou Shalt Not Panic!

Some investors panic and sell all or most of their holdings at the first sign of trouble – despite knowing that the medium to long term trajectory of our stock markets is good. This simply makes no sense! When did Buy High – Sell Low Make sense!

We expect stock markets to  correct and to underperform at times- that is the nature of stock markets and so very important for valuations to remain reasonable and new preferences to emerge-  so the ideal thing is to sit tight and stick to your plan.

Zoom Out at such times and put things in Perspective.  And yes, always maintain some cash holdings for such times.

Remember – Volatility is normal, and happens regularly as individual and institutional investors adjust their expectations of the stock market and their investing habits.  This year is no different.  And next year wont be either.

The next question– do you have a plan? Is your portfolio clearly demarcated between long term holdings, tactical trading and “play money”?

For the long term holdings, we must be able to accept the downturns along with the upswings and use these as opportunities to buy some more. Carefully scan stories where earnings growth and ROE have not been impacted strategically, and there are seasonal or cyclical slowdowns leading to lower valuations – which is a huge opportunity. Stories which  have  seen collapses (falling knives!) – carefully go through what the embedded business is at its lowest historical valuations for instance and whether the company’s governance is good – and similarly, look at buying.

Unfortunately, no one knows when and how much the stock markets will ultimately correct. It may come as a large sudden crash or as a prolonged period of lackluster returns or a confusing ranging market. As the economist John Maynard Keynes famously said, “The market can stay irrational longer than you can stay solvent.

Market timing is impossible as you need to be right twice —when getting out as well as getting back in. And if you think you will time it again, its highly possible you would have missed some of the easiest returns by the time you enter.

For shorter term holdings, just keep your stop losses intact. Every rupee of loss not booked today gives you an extra rupee to buy something more convincing!

Commandment 2: Thou shall not have unrealistic expectations

Analysts and investors alike, to different degrees maybe, have the tendency to move in droves – and exaggerate recent behavior into the near future.  You need to be careful to invest money consciously – a) How much of your portfolio is earnings backed, b) trading at reasonable valuations and risk of valuations compression is within acceptable ranges and c) how much of it is in “hope” territory.

Remember – returns are neither uniform nor constant. There will be swings, both positive and negative, around average returns. And therefore, a large part of your portfolio has to be on the earnings premise and not hope – and to the extent it is on hope, keep a predefined tolerance threshold so you don’t panic when the worst hits. Keep leverage under control for this part and ensure you have cash flows to back up margin demands – don’t  become complacent.

One of Warren Buffett’s most famous quotes advises investors to “be fearful when others are greedy, and greedy when others are fearful.” Big market drops are the best time to follow the Oracle of Omaha’s advice by looking at stocks that have suddenly gotten a lot cheaper to buy.

Commandment 3 :Thou shall not covet one asset alone!

Asset classes do not all move in the same direction at the same time — and that is what careful planning is all about. There will always be asset classes negatively correlated – as one weakens, the other one starts performing. Example, when the Nifty went northwards so did bond yields but midcaps underperformed. When Nifty fell recently, on earnings fears, so did the bond yields – you may have put some bit of your portfolio into high duration  bond  funds which would have yielded excellent returns cushioning some of the impact of the midcaps continuing  to fall.

If a portfolio is constructed properly, it will include asset classes that have low correlation with other classes. This means that at any point in time, some assets or funds will be up while others will be down. This is done on purpose to reduce the long-term volatility of the portfolio. In fact, if you don’t have at least one fund or asset class in your portfolio that is down at any one time, you are probably not properly diversified!

Commandment 4: Thou shall not worry about short-term

Short-term performance is not meaningful when you’re investing for the long run. Emergency reserves and money that will be needed within five years should not be invested in your longer-term investment portfolio. This helps ensure that you can stay invested for a full market cycle (typically four to five years) and avoid the risk of forced liquidation (at possibly depressed prices) to cover expenses.

If you are approaching retirement, you should have already been gradually de-risking your investments (moving into more bonds and cash) to protect yourself from what we financial planners call “sequencing risk.”

A prudent financial plan anticipates these corrections and is  tested to ensure that spending goals over your lifetime will be met despite variable market corrections. It provides you with peace of mind.

Commandment 5: Thou shall control what you can control

One week is a blip on the radar compared to the 20-to-30 year horizons we discuss in relation to investment plans.

During a market downturn or a time of increased volatility, it is important to focus on the things you can control. Example, have you recently called your advisor asking for recommendations on  capital guaranteed funds OR debt funds? Have you studied if your portfolio can withstand the USD INR correcting to Rs 80 or to Rs 60- meaning is your portfolio balanced?

After large corrections, it is often helpful to rebalance the portfolio, as this allows us to buy some assets “on sale” and sell others that are overvalued. Taxes are irrelevant – what matters most is your buying into what you missed out earlier.

The 6th Commandment! Thou shalt not watch news channels!

Keeping up with the beat makes us feel informed.  There is certainly no lack of information or opinion thrust in front of us everyday, leaving the average person the task of sorting through the stacks of fluff and fact.   It is customary for the media to hype market downturns and for the press to present large scary headlines – that’s why you remained tuned in and they cash in.

Remember: Stocks like Cricket stars or Nobel laureates aren’t made overnight –portfolio winners will require hours of grueling pain over years! There will be scandals and notoriety driving headlines but if the star handles all this well, he will soon be a household name! Give him or her time! Just like your stocks.

Remember – A loss is realized only if you sell your investments and lock in that loss permanently. Markets will recover over the long run. Try not to look at your balances too often, and try to tune out the media to stay level-headed.

There is a saying “If you make decisions based on the headlines, you’ll soon be delivering the paper.”

Maintain your composure by focussing on things that are positive in your life: family, health, relationships, dreams and achievements — things that all the money in the world can’t buy!.

As Mr Spock always meant: Stay calm and prosper!

 

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