Last Updated on February 12, 2022 at 6:17 pm
For the first time in the history of the Indian capital markets, we have so many first-time investors -many in this 20s and 30s -facing increased turbulence in the markets and fears of a global market crash. So it is natural to have questions like “How to protect our MF investments during a market crash?” and “should I wait until the markets have settled down?”. This is a discussion on how young earners should plan and prepare themselves for a market crash.
This article stems from an email received from a reader, Satya. Hello Sir, I have been watching your videos and reading your blog for a couple of months. I see that you are putting most of your savings in MF. I want to know how to protect your MF investments during a market crash? I’m 40 and I want to start investing but I worry too much about Market Crash and I’m sticking to FD’s. I would really appreciate it if you can suggest to me how to mitigate the risk during a market crash? Thanks, Satya.
So let us start with the basics. Loss from equity investments (stocks or mutual funds) do not arise just from market falls or crashes. In fact, the biggest enemy for an investor is a “sideways market” where the market moves up one day, down the next for weeks, months and years.
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Since time is money (quite literally), the longer it takes for the market to move up, the lesser would be our returns. Along with market fall, this is known as a sequence of returns risk or colloquially “bad luck”.
I am sure you would agree that we cannot let luck decide our investments, our future goals, and our dreams. The mutual fund industry wants us to do precisely that. Regardless of whether our “long-term” investments do well or not, they would earn via the expense ratio. Hence the mantra, “do not stop your SIPs”! Higher the fear associated with market turbulence, louder the chanting.
Buying mutual fund units on the same day of each month (aka SIP) and assuming it will work out in the long-term is more dangerous than a market crash. I have earlier shown How the fate of your mutual fund SIPs is decided by “timing luck”. Here is another illustration.
At the time of writing, the Sensex is down 0.45%. If it closes in the green today, the fear of a market crash for most investors will probably evaporate. We need to do better than this. Let us consider an entirely imaginary situation where the returns from March 2020 to Oct 2020 are identical to the returns between Jan 2008 to Nov 2008. Then this is how the Nifty (including dividends) would look like.
This is not a prediction but an imagination to understand and appreciate risk. Needless to say, it is a mighty fall. Imagine a SIP in Nifty 50 index fund started 10 years ago, in March 2020.
The month on month variation in the annualized return of the SIP obtained using the Mutual Fund SIP XIRR Tracker is shown below. Notice how sensitive SIP returns are to market fluctuations even 6,7 or 10 years after starting the SIP. This is the ground reality. As shown earlier, Mutual Fund SIPs Do Not Reduce Risk! Beware of Misinformation
After 4Y, the returns were about 17%, went all the way down to 6% about two years later. The lastest return is as indicated above, 9.67%. I am astonished how some investors look at this and say, “hey 9.67% after 10 years, that is not so bad, is it?”.
The point about risk is entirely lost on them. Suppose this SIP was started five months before March 2010, in Oct 2009, then its current fate would be 8.51%. A person who started investing in equity in Oct 2009 surely would not have expected just 8.5% returns! It was tax-free then, taxable now. This fluctuating returns and the way the returns respond to market movement is referred to as “timing luck” or just luck is good enough!
Some people argue 8.5% is still good. Unfortunately, it is acceptable if I had expected a 9% pre-tax from equity and ended up with 8.5%. Most people expect 10%, 12% even 15% and invest proportionally.
The problem is, if you invest a double-digit return and get less, your corpus would fall short of its target because you invested less. This is a risk that eludes most people. So what is the solution?
How to protect our MF/equity investments?
- Investing with a clear goal in mind is the best way to lower risk as it allows you to focus on the targe corpus and not target returns. Yes initially a return expectation is necessary, but the above should convince you to keep it as low as possible.
- Once there is a goal, there is a deadline and this means the equity in your portfolio should be reduced many years before the deadline. Want proof? Check this out: How to reduce risk in an investment portfolio We discuss alternate risk-reduction strategies in the lectures on goal-based portfolio management no matter what the market conditions
- When the equity in the portfolio is to be varied as per a set plan (not depending on market conditions), the overall portfolio return would continuously change.
- So all that matters is how the investment corpus is expected to grow and what is its current position. Members of the goal-based portfolio management Facebook group (link above) discuss these ideas and some have also implemented this.
- Once there is a variable asset allocation plan in place, periodic rebalancing of the portfolio will reduce risk. The peace of mind that the investor is on the right track should make them sleep better.
It is the lack of a proper plan that makes investors fear the market and doubt their own decisions. It would make a big difference to an investment portfolio and peace of mind if such a plan with personalized inputs is set in place. This can be done with the Freefincal Robo Advisory Software Template.
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