How prepared are you for Stock market fall?

Published on June 17′ 2015

Just asking, I know you don’t want to see a fall and have invested or been sold with a view that markets will keep rising for next few years due to strong and stable political scenario, Make in India efforts, low Interest rates, India gaining good global attention and what not. But you cannot ignore the negatives too, which have its own impact.

What is more negative for Indian stock market or in other words, what could lead to a big fall in India stock markets? Greece Default, Oil Price rise, Dollar strengthening, Interest rates hike in US, inclusion of China A shares in MSCI EM Index, low corporate earnings…?

Actually all are negatives and stock market had reacted to almost every news mentioned above and it will keep on reacting to such news in future also. Infact in a country like India where the markets are more dependent on foreign investments, foreign happenings creates huge impact.

Though there are some positives also but still being a global economy, risks outweigh the opportunities, at least at this moment.

Sunil a new investor who’s started his investments with a ULIP and close ended fund is keeping worried these days after experiencing the recent volatility. Being a novice he is finding difficulty in accepting fact that like Rise, fall is also a reality. He invested in equity market believing that last 1 year return will continue for next 5 years also, but now his small portfolio is 10% down, which is bothering him.

When he shared his concern with me, my only answer to him was – Hope for the best, but be prepared for the worst. Equity has historically been a great investment, but the good returns come with good cost in the form of volatility and to make money you have to tolerate occasional declines.

But it’s easier said than done. Investors are suffering from many behavioral biases which make it difficult to take rational decision, especially on emotional subject of Money. Investors are loss averse and would not like to come out of stock or fund at loss even if it is not wise to stay invested. Investors believe that Recent happenings will remain continue for long, that’s why they made huge investments in 2007 and also in last 1 year, but not in 2008 after witnessing the then stock market fall.

Those who’ve experienced Stock market fall of 2008, in retrospect would agree with me that market declines have been great opportunities to buy more of equities. Clearly those who thought that stocks were too risky after 2008 crash missed out on great subsequent returns.

So what do you think? When would be the next stock market fall? Are you prepared to see that fall? How panicky would that be for you? Would you like to invest more at that time or would like to stay away from the stock market during that time? No I am not trying to predict the future, but prepare for it. Stock markets can fall anytime and it has so many reasons for that, but you being an investor should be prepared enough to embrace that fall, reduce the considerable losses and optimize the gains.

Below are some pointers which if followed can help you in preparing towards next stock market fall:

Stay away from close ended funds -keep investments Flexible and Liquid:

To not let falling financial markets bother you, your investment portfolio should be liquid enough to be withdrawn anytime and also can be repurchased and average out as and when required. These benefits are not existent in Close ended equity funds. Close ended funds are sold majorly in rising markets by showing lot of benefits which may suit to the fund house, but it does not result in considerable benefit to the investor.

Structure wise these are not flexible investment option which though guarantees a stable AUM to the fund house but not stable returns to the Investor. Neither investor can do Systematic transactions, nor can make additional purchase during fallen market days. This structure is a big hindrance in the rebalancing of Asset Allocation.

Have decent bond allocation:

Your portfolio should not only be comprised of equity funds, but also should have decent bond allocation too. Debt provides necessary stability to the portfolio and during volatile scenario it acts as hedge against equity exposure. If you remember the crises of 2008, when worldwide economic growth was declining then to support the necessary growth central banks had started reducing the interest rates which helped the long term bond to gain in value which compensated the falling equity returns.

This is just an example and I am not saying the same situation may repeat and debt funds would come to your rescue but just want to show the importance of having a balanced portfolio. Also make sure that you have invested in a good quality bond funds/papers.

When we say debt, it does not only mean the debt mutual funds. Even Bank FD, Post office schemes, PPF etc. comes under debt category, but since these does not invest in trade able securities, it does not benefit from fall in interest rates. So there has to be balance between bond funds and other debt allocation.

Debt exposure also helps in maintaining the necessary liquidity which further helps in making additional purchases in equity segment during falling market. This is another benefit of keeping flexible and liquid portfolio.

I also agree that a debt fund doesn’t look too attractive in rising equity market scenario, but it acts as a savior in falling market.

International diversification:

International diversification results into managing the risk due to currency fluctuations. When dollar appreciates it certainly has negative impact on Indian imports, Oil prices, overseas loan interest cost etc. which in turn impacts negatively on stock market, but having some exposure to international funds balances the risks. Dollar depreciation also sometimes has negative impact so , your exposure to international funds should not be more then 10% of overall portfolio.

By now you must have understood that what I am writing about here is diversification and Asset allocation which is an integral part of overall financial planning. When you don’t follow a structured, goal based approach you tend to take investment exposure into the then favorite asset class. But what you don’t understand is that you won’t be able to exit out of it when suddenly it goes out of flavour due to many factors which are not in your control.

So it is always wise to design a portfolio which limits the downside as well as provide you enough flexibility to take benefit during upside.

You never know which side market will move tomorrow. Long term always looks good, but to achieve that long term returns one has to deal with short term volatility too. That short term volatility sometimes bothers so much that investors make mistakes of going off the market completely and reenters at wrong time.

Conclusion:

Structural Asset allocation helps in reducing the behavioral mistakes which investors tend to make during volatile market atmosphere. And proper timely rebalancing lets investors apply the buy low and sell high formula effectively. Otherwise you keep on running after the “in flavor” asset class.

Preparation towards stock market fall means having a structural approach which does not bother in any market scenario and lets you take advantage of both sides by optimizing the overall returns.

What other steps one can take to prepare for stock market fall? Do share your views