With stock markets oscillating wildly, the bigger concern for investors is to protect their investments over the downturn, rather than clock aggressive growth during the upturn.
Protecting your investments in a falling market is easier said than done. It involves taking on that precise quantum of risk that can spur your investments in a rising market and cut losses in a falling market.
While this sounds very difficult (and it is, even the best fund managers often struggle in striking this sweet balance between risk and return), we have not one, but three ways for you to stay on top of stock market volatility.
1. Good old balanced funds
Balanced funds, if you still remember them, are asset allocation investments. They invest across equity and debt markets (minimum 65% of assets in equities), which leaves them well placed to serve three objectives:
Shift across asset classes based on the best available investment opportunities.
Use the debt component intelligently to de-risk the equity portfolio during volatility in equity markets.
Book profits in equities regularly which again de-risks the equity portfolio by capping the level.
Like balanced funds, monthly income plans (MIPs), offer a similar investment proposition, although to a lesser extent. Since MIPs usually invest 15%-25% of assets in equities they are suited for investors with low-to-medium risk appetite.
In a falling market, when being fully invested in equities can prove perilous, a balanced fund with a 35% debt component might just be what the doctored ordered.
2. Investing through SIPs
Unlike balanced funds, which are usually ignored, SIPs have been widely adopted by investors. The reasons are not far to seek. Investing Rs 500-1,000 every month is a lot easier on the wallet than investing (a minimum of) Rs 5,000 lump sum.
By investing smaller amounts at regular intervals, you can reduce the average cost of your mutual fund investments over a market cycle. This is possible because when markets are volatile, SIPs activated during that period lower the overall average cost of purchase.
So investors who have opted for the SIP route welcome the volatility in stock markets and look forward to more of it going forward.
3. Always stay diversified
When markets are on the rise and everything appears hunky dory, that's when investors are most prone to make mistakes. That is the time when various high risk investments like thematic/sector funds are spawned.
Since a rising tide lifts all boats, most fund houses are quick to respond to a rally by launching high risk investments like thematic funds which they otherwise would not have launched.
Taking on higher risk pays rich dividends in a rising market, which explains why investors are prepared to risk their monies in a thematic fund that they would otherwise not have done.
Don't believe us? Compare the number of investors who invested in technology/software funds in 1999-2000 (before the tech crash) with those who invested in them in 2000-2002 (after the crash). Once the tech crash had set in, technology funds were the most reviled investments.
On the other hand, investors who were invested in well-diversified equity funds were relatively better off in the face of market volatility.
We see a similar situation emerging at present. Investors are going all out to invest in infrastructure funds ignoring the higher risk and the fact that they are in the midst of a stock market rally which enables such funds to generate above-average returns.
If the markets were to correct sharply, themes like infrastructure could be the hardest hit making investors in thematic funds wish that they had invested in diversified equity funds instead.
