In a falling market, the value of your investment keeps going down.
However, the reduction in value is purely a notional loss if you remain invested.
When you redeem in a falling market, the notional loss becomes a permanent loss, explains Anamika Pareek
The market has been volatile since October, with the Nifty tumbling by more than 2,000 points or 10 per cent from its all-time high. The Nifty bounced back after the US election results were declared and then gave up the gains in subsequent trading sessions. Volatility may continue in the near term since there are concerns about weakening corporate earnings and interest rate cuts by the RBI.
What should be the stance of long-term investors during such volatile situations?
Let's discuss some common mistakes that you should avoid as an investor, in order to remain on track to achieve your financial goals.
What mistakes should you avoid making during times of volatility?
The first thing to understand is that volatility is unavoidable and natural, and it can occur any time. When you are ready for volatility, you are more likely to react rationally when you find yourself in volatile markets.
Here are some mistakes that you should avoid in volatile markets that can help you avoid losses:
Panic selling
Greed and fear are common behavioural biases. When the market keeps falling, fear begins to affect investor's psyche. When fear turns into panic, investors redeem their investments. In a falling market, the value of your investment keeps going down.
However, the reduction in value is purely a notional loss if you remain invested. When you redeem in a falling market, the notional loss becomes a permanent loss.
Remain patient in volatile markets. Historical data shows that the market eventually bottoms out and recovers.
Stopping SIPs
Many investors do not want to invest when the market is going down. Some stop their SIPs in the falling market due to the fear of making more losses. SIPs can actually help you take advantage of volatility through rupee cost averaging.
In falling markets, you can acquire more units with the same monthly investment if the NAVs are going down. Continuing your SIP in volatile markets can help to get higher returns over the long investment horizon.
Bottom fishing
Some adventurous investors attempt bottom fishing during corrections. Bottom fishing refers to the tactic of buying stocks that are trading at low prices or buying stocks whose price has declined the most. You may get tips that such and such stocks are trading at rock-bottom levels and will produce multi-bagger profits.
Avoid acting on such tips unless you have a thorough understanding of stocks. Stick to mutual funds, which invest in a diversified portfolio of stocks, which are well researched and managed by experienced investment professionals.
Trying to time the market
One common mistake that investors make is attempting to start and stop investing based on market lows and highs. Predicting market peaks and bottoms is not only extremely difficult, but also quite unnecessary if you are a long-term investor.
Time spent in the market is much more important than timing the market. Wealth creation is higher over the longer investment tenures due to the power of compounding.
Avoid herd behaviour
Herd mentality is a common behavioural bias in investing. Herd behaviour causes extreme volatility. Do not make buying or selling decisions based on what you see others are doing. Behavioural biases trigger irrational reactions to events in the market.
A rational investor avoids becoming a victim of behavioural biases and remains focused on her/his financial goals.
Don't put all your eggs in one basket
Historical data shows that winners rotate across asset classes, market capitalisation segments and industry sectors. For example, small and midcap stocks outperform large caps in bull markets; large caps outperform small and midcap stocks in volatile markets. Therefore, asset allocation -- spreading your investments over different asset classes and market capitalisation segments -- will reduce volatility and bring relative stability to your portfolio.
Avoid reacting to market rumours
There may be all kinds of information in market grapevine, like ABC company is about to acquire XYZ company, the government is about to bring some policy change etc. In bear markets, you may hear some so-called experts making doomsday predictions.
In the age of social media, sensational information may get amplified, but you must not give credence to such information. Information coming through the market grapevine is often rumour and hence untrustworthy.
You must make your investment decisions based on accurate information that you can verify with credible sources. Consult with your financial advisor or mutual fund distributor if you need help in making investment decisions
Volatility versus loss of capital
Investors should recognise the distinction between volatility and loss of capital. Volatility is fluctuations in price. We may go through extended periods of volatility when prices are declining. Price volatility can turn into a loss of capital if you redeem your investments.
But if you stay invested, the market will eventually recover and there may be opportunities for your capital to grow.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this QnA or an attempt to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
