Investors are right to feel jittery. Stock market volatility is not easy to stomach, specially when you see your life savings plummet in value only to watch a rally 48 hours later that throws you off guard. Periods of sharp price movements in either direction tend to trigger an emotional response from investors. And emotions do not mix well with investing.
On the one hand, the proponents of “buy-the-dip” are screaming themselves hoarse. On the other are the market prognosticators who tell us that dismal market days will soon be upon us, thanks to inflation, rising crude prices, war and supply side constraints.
How does one keep their sanity in the midst of such emotional upheavals and so much noise?
Do Not Conflate Stock Performance With Business Performance
Fear sells. A precipitous market drop induces panic. And that is the time investors need to fight off the urge to sell their shares and crystallise losses.
Your sell decisions should never be made solely on stock price movements. Guiding them should be the performance of the underlying business. Revisit your investment thesis. Seek to answer these questions: Is this business growing and making more money per share than it did a few years ago? What is the potential value of the business 10 years down the road?
Professor and investor Sanjay Bakshi suggests three factors in the analysis:
a) Businesses that can deliver growth without stretching balance sheets.
b) Those that can deliver growth without taking in more capital through the issuance of new equity shares.
c) Businesses where the quality of growth is excellent in terms of incremental returns on capital.
Getting a grip on the above factors will help you make decisions based on the business performance, and not get swayed by the stock performance. It will also throw clarity on the distinction between external stock market forces driving a stock price as against business reasons. It will reveal to you whether or not potential growth in value is mispriced by the market.
Do Not Focus On What You Cannot Control
Focus your energies on things you can control and tune out what you can’t.
1. Revisit your rate of savings. Are you saving enough? Can you save more? Can you increase your systematic investment plans (SIPs)?
2. Review your long-term asset allocation. Has it become heavily skewed towards one asset or stock?
3. Is your emergency fund adequate?
4. Are you insured?
5. Are you building up skills? Human capital is as important.
You hold no sway over the direction of the economy or the market; they are going to do what they are going to do. But you do exert influence over your own situation: how much you save versus spend, how you have allocated your portfolio, whether you have built an adequate cash cushion, and so on. Keep your focus there.
Do Not Take Your Eye Off The Ball
What must you do when the market has rallied so dramatically that you are sitting on a tidy profit? When you have made more from the investment than you anticipated, it takes courage to head for the exit. Because there is always the lure of more: “If I wait for a few more days, I can make more.”
Before selling, always ask yourself, will selling take me closer to my goal? And just to be clear, your goal is wealth creation. Your goal is not to make profits–that is the goal of a trader. There is a popular story about a conversation between writers Kurt Vonnegut and Joseph Heller. They were at a party on Shelter Island, hosted by a hedge fund manager. Kurt joked that the host may have made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responded, “Yes, but I have something he can never have. The knowledge that I’ve got Enough.”
A lot of people incorrectly assume that they need enough money to do nothing. You just need enough to do whatever you want. The power is having a choice. The choice might be to work less to spend more time with family, to go back to university, to start your own business, to travel, or perhaps even take a job that pays you less but gives you purpose when you wake up in the morning.
As investment guru Bill Bernstein once advised, “If you have won the game, stop playing.” You need to identify your own version of “winning” and “enough”.
Do Not Ignore Asset Allocation
In a rampant bull market, it’s easy to go with the flow. If a stock has risen to a point where it becomes too big a part of the portfolio and gives you sleepless nights, sell it down to the “sleeping point”. It’s not just about making money; it is also about living a stress-free life. What’s the point of becoming so rich that you’re unable to even sleep? Pare down exposure in a bubble market, if you want to reduce your anxiety. In other words, practice asset allocation.
Don’t Try To Time The Market As A Consistent Strategy
In recent times, investors have borne witness to an extremely volatile market and a strategy that has caught everyone’s fancy is “buy-the-dip”, which essentially means buying when the market dips dramatically. This goes against the systematic investment strategy and entails investors holding money on the sidelines to enter during a crash.
Fundamentally sound, but execution won’t be pretty. To start with, market irrationality can last a very long time. Further, trying to pick a single-entry point requires you to be extremely hands on and mentally astute.
Let’s say you are sitting on a pile of cash, waiting to buy some stocks. The market drops by 10 per cent. You wait. It drops by another 10 per cent. You wait because you are convinced it will fall further. It declines another 10 per cent and now you are convinced bad days are coming, so you want the market to bottom out. Suddenly, a rally commences. You missed timing the bottom. You lost out investing at lows.
Even if you did catch the dip and invested, how much would you invest? If you invested the entire amount and the market fell further, you would have missed the bottom. If you invested just a portion, where will you park the balance so that you can access it within a day?
Then there is the psychological impact of having to pull out money from your safe haven at a time when the market is sliding downwards.
Markets are marked by false bottoms (and ceilings)—points at which it appears that stocks won’t fall (or rise) further but then proceed to fall (or rise) even more. Anyone who tries to trick the bear (or the bull) by piling up cash will likely suffer less-than-perfect timing and miss out on big stock market gains. Unless you are extremely lucky every single time, you won’t get rich playing the timing game.
The author is Senior Editor at Morningstar India