Investor’s Guide to Volatile Markets
The only thing certain in life is uncertainty. As humans, we shun uncertainty and take measures to be prepared. We constantly strive for control in our lives… In fact, uncertainty (termed as volatility) in the stock markets makes us uncomfortable. At the same time, we know that if we can stomach this uncertainty, we will be rewarded with supernormal returns.
When volatility increases to unprecedented levels due to Black Swan events, such as the present Covid-19 virus, it usually leads to panic. Investors mindlessly start liquidating their equity investments without considering fundamentals of the stock, valuations, and the future outlook.
Markets move in cycles and even Black Swan events such as what we are facing today, will eventually abate, and we will see the market reverse direction.
In fact, during such times, it’s critical to stick to your investment plan. You could even tweak the plan to invest in stocks that are fundamentally strong, but whose prices have fallen in sync with the broad market fall. In other words, don’t get shaken by day-to-day market gyrations. Think long term and think objectively.
To tackle market volatility, you need to address two factors – have a plan and take control of your emotions.
An investment plan
Every investment you make should be linked to a financial goal such as retirement, wealth building, marriage, education, etc. Compute how much you will need for each goal, and based on expected returns from the investment, compute how much you need to invest to accumulate the target amount to fulfil the goal when it arises.
Humans tend to be emotional about almost every aspect of their lives. This includes investments. Where your financial security is concerned, emotions are bound to play a role. You want yourself and your loved ones to be financially secure. While there is nothing wrong about this, when it comes to planning your investments and monitoring price moves, you must remain objective. Here, if you let emotions get in the way, you will eventually end up making mistakes, which, in turn, could set you back in fulfilling your financial goals.
A very important factor that will help you keep your emotions in check is to study the company you have invested in – its fundamental strengths, management, business plans, ability to innovative, its position in the industry group it belongs to, etc. Now if the price of the stock is volatile, keep in mind the fundamental strength of the stock and look at the stock price in relation to this; assess whether it makes sense to buy more of the stock, hold or sell at the current price. This will help you think objectively. Remember the market works more on sentiment and less on valuations. You could use this sentiment to your advantage.
Recent developments have a higher impact on our emotions; for instance, a large drop in the stock markets will be on top of the mind while past market gyrations will be relegated into the background. In fact, we assume that what is happening currently will also continue happening in future. This then results in acting on this wrong presumption. Markets don’t stay the same throughout history; there will be ups and downs – and you must be prepared for change. In fact, a lengthy bull market or even a bear market makes us falsely believe that this is how things are going to be from now onwards; this is completely untrue. As we have said earlier, markets go through bull and bear cycles and nothing is constant.
Let’s consider the Black Swan event of 2008. At that time, most investors mindlessly liquidated their holdings. When the markets turned into an upcycle, they realised their mistake. This is a lesson for investors that panic selling can be costly.
Know your risk tolerance
Before you invest, understand your mindset towards risks. Volatility is an integral part of equity investing. While risk can be largely mitigated with in-depth research before making investments, extraneous events such as the current Covid-19 pandemic, can create volatility, which is beyond anyone’s control. If you have the stomach to handle such volatility, the eventual gains can be very attractive. Always remember – higher risks implies the potential for higher returns.
Types of Investment Risk
There are various kinds of risks inherent in investing. Some of these are:
Market Risk: This implies the extent the price of your investments will move (up or down) with general market trends.
Timing Risk: Let’s say you invest and, the very next day, you see the price of your stock having fallen significantly. This implies timing risk.
Geopolitical Risk: Global developments such as war, political upheavals, economic policies, etc. fall in this category of risks.
Using a professional investment team
We have always said that investing is a complex exercise where numerous factors need to be considered before making any investment decision. Having a professional team of experienced and knowledgeable investment professionals making and monitoring your investments will not only help you have fundamentally strong stocks forming a part of your portfolio, you will also see your portfolio being monitored closely in tune with market moves based on micro and macro developments.
Timing the market is a tricky thing. Professionals use technicals to assess market moves. They then relate these technicals to future implications of current developments in order to decide whether to buy, hold, buy more, sell a part or completely sell out. Every decision is made based on robust debate considering various factors. You not only benefit from these thoughtful decisions being implemented on your portfolio, you are also educated on reasons for every decision being made.
A number of investors believe that buying good stocks and simply holding is all that needs to be done. The truth is, when there is a fall, all the gains that you would have seen in your investments could be erased and you would not have taken any action. This is where active investment management has a valuable role to play. Exiting at the appropriate time and re-entering the stock helps lock in your gains.