Stock markets are volatile; sometimes they resemble a roller-coaster ride. Five percent corrections in the market are common. Corrections of about 10 percent can happen every year. Crashes of 20 percent happen less frequently. During times of major crises there can be worse crashes like during the Covid crash of 2020, the Global Financial Crisis induced crash of 2008, the Dotcom Bubble Burst of 2000 and the crash following the Harshad Mehta Scam of 1992. Most people panic during a crash, sell and get out of the market, incurring huge losses. In India, this has happened during the market crashes of 1992, 2000 and 2008. To be a OUR VIEWS successful investor, this panic behavior should be avoided.
The important question is: how to remain calm during a storm in the market?
Focus on what you can control, stay invested
There are some aspects in our life that are outside our control. This is partly applicable to our finances, too. So, the first thing to do during a crisis is to distinguish between what you can control and what you cannot. Then, it is commonsensical to accept what you cannot control.
An important trend noticed in market behaviour is that crashes are followed by sharp recoveries. So, those who panic and get out of the market during a crisis lose out when the market stages a recovery. For instance, after the Covid-19 crash of March 2020, the market staged a ‘V’ shaped recovery. Nifty shot up from the Covid low of 7,511 in March 2020 to above 22,500 by March 2024, tripling in four years. Those who panicked and sold didn’t benefit from this recovery. So, it is important to stay invested. What are the safeguards to remain calm during a market storm?
Don’t borrow to invest/trade First and foremost, it is important not to be leveraged. If an investor has borrowed to invest, he will be forced to sell to repay the loan, whatever be the price level. Similarly, if the investor has taken a trading position in the market, he will be forced to square the position. The impact of closing long/short positions during a crisis will be huge. There are many instances of traders, particularly newbies, incurring huge losses in F&O trades. The loss from speculative trading can be huge during a crisis.
Diversification helps to cushion the fall
If your investment portfolio is well diversified consisting of equity, bonds, gold and cash, the impact of the crash will be less severe since only equity is impacted during a crash. So, diversification helps. Similarly, geographical diversification helps in absorbing the shock of a crash if the crash is country specific.
Rebalance the portfolio
A crash may turn out to be the right time to rebalance your portfolio. Defensives like consumer staples, pharmaceuticals, utilities, and stocks of companies with strong balance sheet fall less during a crash. There can be sectors that do well even during a crisis. For instance, during the Covid-19 crash of 2020, pharmaceuticals remained resilient and moved up. When the world became sick due to Covid, the pharmaceutical industry boomed due to sharp surge in demand for medicines.
Stay with quality large caps: Ships are safer than boats
Ideally a portfolio should consist of predominantly high[1]quality large caps. Small caps will collapse during a crisis. Liquidity in small caps can disappear or turn out to be extremely low during a crisis. Selling and getting out, even at a big loss, would be difficult. Many small caps, sometimes midcaps too, will be frozen at the down circuit during a crisis. This has happened many times in the past.
Ships generally stay safe during a storm compared to smaller boats. Their larger size, more robust design, advanced stabilization systems, and trained crew who can navigate through rough weather make them safer than smaller boats. Smaller boats are more vulnerable to capsizing due to their smaller size and less stability when encountering large waves. This logic is applicable to stocks also. Many small caps have disappeared from the market during a crisis resulting in huge losses to investors. Quality large caps, after the initial turbulence, stabilise and bounce back.
That said, it is important to understand that small and midcaps outperform large caps in the long run. To benefit from the outperformance of small and midcaps, it is ideal to invest through the mutual fund route. More important, investors don’t lose their capital in well[1]managed mutual funds, which may happen when investors select small and midcaps to invest.
Remember Warren Buffet’s famous words: “There are two principles of investment: First principle, don’t lose money. Second principle, don’t forget the first principle.”
