Don’t get too comfortable with equity: This is how a real market crash “feels” like

Published: July 4, 2017 at 10:29 am

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So you think you have become financial literate by starting equity mutual fund SIPs assuming that they will beat inflation in the “long run”? Don’t get too comfortable with equity. Don’t assume those fairytale returns from DSP nanocap fund will last. This is how a real market crash “feels” like.

Preparing for a presentation can be really fun when you have to make all new slides. I got a gig at the RBI staff college next week and as I was preparing to give the audience post-lunch indigestion speaking about the market-risk, I thought it would be a good idea to turn them into a series of posts about risk (what else!) and what we need to know about the great industry/media propaganda – the SIP.

In part one, I simulate a “real” market crash.

First, we start with the NAV movement of Franklin Prima Fund

Excuse the reference to “blue dots” that is a cut and paste overkill.

Now, let us look at this in the proper perspective by using a logarithmic scale. This will divide the vertical axis into equal sized chunks. I prefer the log to the base 10 rather than the usual log to the base e (or ln) as it is more granular. Those who are new to these type of plots may consult this post: Are you ready to climb the Sensex Staircase?!

Notice that the recent increase does not seem so steep because now you can see that relative to past growth. Now let us focus on the dot-com crash.

This is how the NAV fell. Those who consider a 1% o r 2% drop as a crash may kindly imagine what this would do to a portfolio.

Now, I would like to imagine the above % monthly change in NAV to be repeated from next month on. Of course, this is a pure speculation based on cherry-picked data. But cherry-picking reward is different from cherry-picking risk. The former is delusional and the later dreadful. And I would always choose the latter.

Fasten your seatbelts!

The red dots are simulated. Why is a crash that “looked” so mall in 2000 appearing so gigantic now? Again, because we are not looking at in the right perspective.

Both the crashes are essentially identical. The heights of both arrows are the same. This si the power of the log scale (log 10 scale to be precise due to the 0.5 granularity in the vertical axis.

The standard log to the base e or (ln) graph will look identical but notice the y-axis.

Please do not assume this crash simulation is a fantasy.

Please do not assume the SIP corpus will ensure market will never crash. That is garbage. If and the when the FIIs pull out, the market will head south. As simple as that.

So what would happen to the great SIP due to such crashes? To be continued …..

Ps. Of course this, is a simplistic illustration of a crash. The point is, to be forewarned is to be forearmed.


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