The stock market does not maintain a straight line. They have peaks and troughs, and are extremely difficult to achieve the timing right when you’re guided by your instincts. The hazards of market timing include missing out on good price moves while waiting for the proper opportunity, and it is generally impossible to forecast when a trend will shift. Almost all studies suggest that for an average investor, buying and holding gives far greater rewards than attempting to time the market. If you try to time your entry or exit in the market, you run the risk of selling cheap and purchasing high.
It is critical for investors to realize that long-term success is what is crucial in a stock market. Investment is not for the short-term investor since markets may be very volatile in the short run, particularly during bear markets.
Stock prices typically fall during a market slump. It’s unpleasant to see your portfolio’s worth plummet from one trading session to the next. But try to tell yourself that you’re simply witnessing a loss on the screen, nothing more than that. This concept is also known as ‘Notional loss’.
What happens during a market downturn:
A recession is a sign of economic downturn within a specific location or all over the world. A recession is commonly referred to as two quarters of economic downturn in a row. During such recession, investors should be extra cautious about how they manage their money. In the economy as a whole, recessions maybe accompanied by high levels of unemployment, reduced job vacancies, reduced savings and increased government welfare.
The simple fact is that stock prices normally fall during a recession. So, the value of your stock normally declines, implying that your holdings make a loss. People frequently pull the amount from their investments right away. When investors get concerned, they typically sell risky bets, such as stocks, and move their funds to safe assets, such as bonds or gold. Don’t buy or sell in frenzy when stock market collapses. Emotions are not a reliable guide for performance.
It is critical to remember that we have consistently emerged from downturns in the past. This explains why investing is always a long-term strategy. So adhere to your long-term strategy. The strategy should be able to withstand the peaks and troughs of the share market.
(We will just try to understand the basic difference between a ‘Recession’ and a ‘Depression’. Recession is a general economic downturn that normally lasts for two to 18 months. A depression is a more severe slump in the overall economy that lasts several years. In this blog-post, we will only discuss about recessions, as depression is something that happens once in 50 years or 100 years, but recession is bound to happen once in every decade on average.)
Historically in the markets worldwide, a recession typically lasts for five months on average. What exactly does this imply for an investor? This implies that you don’t have to take an emotional choice during recessions. The basic understanding comes on the fact that invest in the stock market only if you are financially prepared to do so.
So let us discuss some important points that can be followed by investors during the times of market downturn and whether investing during a recession is a good choice or not.
1. Rupee Cost averaging is the best:
You may believe that it is advisable to avoid the stock market during a slump. However, this is an excellent opportunity to invest. Occasionally, you will get the opportunity to invest in high-quality stocks at a reduced price. Because no one can foresee when a recession will occur, one of the greatest tactics at the times of economic downturn is to invest continuously, regardless of what is happening on in the economic system or in the market per say. This is sometimes referred to as rupee-cost averaging. This removes the element of chance or emotion from the investing process, allowing an investor to purchase extra when prices are low and perhaps less when prices are inflated. This can be achieved by automating your investments, so that you will stay put in the market and investing regularly despite the market movements.
2. Rebalance your investment portfolio:
Think about adjusting your holdings. This means that if stock prices decrease, you effectively acquire more stock. You do this by disposing part of your portfolio’s safe assets, such as bonds. Restructuring your investment portfolio allows you to maintain the risk tolerance that you initially put up in your portfolio. You also profit by doing this because as market goes up, your equity investment will stand to gain more.
3. Portfolio Requires Diversification as well:
As we all know, diversification is the strongest instrument while investing, and while making timely investments, it also makes perfect sense to invest your money in a broadly diversified portfolio. Diversification, like the adage “Don’t put all your eggs in one basket”, can shield you against large falls in the market by investing in assets that behave differently in various conditions at all periods. For example, gold is a good hedge against inflation and also a good investment at times of market downturn, as it becomes safe haven investment during recessions. But again, the exposure to gold also should be based on your original asset allocation mix and you should not increase allocation to gold tremendously at the times of market downturn.
Also, if you’ve suffered heavy losses in your previous investments, do not really attempt to compensate for them by taking on greater investing risk.
4. Do you have that Emergency Fund Ready for Downturn?
Whenever there is market instability due to a crisis, people should indeed be ready for the worst-case scenarios such as loss of employment, company failure, reduced income, no-savings, and so on. No one really knows how severe the recession will be for the market, but having a strategic financial plan in place and being equipped for any events is critical. An emergency fund is a means to protect you against job loss and other financial troubles. It is the foundation of a financial planning and can be a helpful cushion instead of going on debt to pay your daily costs or pulling out money from long-term assets that could have already lost value during a market crash. Even if you believe that your employment is safe and dependable, you are not immune to a loss during a market collapse. An emergency fund equips you to fight unforeseen situations.
The next question is how much money you should put aside for an emergency fund.
A good rule of thumb is to have three to six months’ worth of your salary saved up. Ensure that this money is kept liquid and there is no inherent risk. It is critical to assess the size of emergency money that is appropriate for you and your family, and you also need to re-evaluate the emergency fund every year once, as your income may increase every year and hence are your expenses. So, the emergency corpus should be in line with your latest salary or income.
5. Is it better to pay-off your debts in times of market downturns?
It’s no surprise that debt is a concern at any stage in your life. There are several factors to consider if you are faced with the decision of paying off debt versus investing. Debt may take numerous forms, including credit cards, education loans, home loans, personal loans, car loan and so on. The first item to consider is the interest rate you’re paying and the length of the loan tenor. Then compare it to your estimated return on investment. If your debt has a high interest rate, it’s typically a good idea to use your surplus cash to pay off your debts before making any new investments. Debt repayment provides a definite rate of return, whereas investment can be uncertain and unpredictable. You may discover that paying off your debts is more beneficial than boosting your asset holdings.
6. Stick with your investment strategy:
Don’t let the enticing pricing of investing possibilities convince you to abandon your investment strategy or goal. During a market downturn, you’ll want to be sure you’ve ticked all the checkboxes before making new investments. An investing strategy will hold you responsible for your financial goals and investment plan. And, if your strategy permits for additional investments, only then you should employ your surplus funds in the market during a recession. When growing your investment portfolio, be sure they are consistent with your objectives and risk appetite.
7. Keep in mind that Downturns are a usual routine:
Stock market drops are rather common. There may be times when investors are spared, but overall, corrections, in which equities lose 10% of their worth from a recent peak, are typical. You’ll be less inclined to panic if you keep this in mind. Some equity market declines are more protracted than others. However, it is feasible for shares to have a solitary terrible month and subsequently recover. These bear markets are minor in the overall picture of a decades-long investment journey.
8. Even if it is downturn, don’t keep all of your extra money in cash:
Perhaps you tend to control your finances well and don’t spend all of your salary or income. It may be enticing to retain your spare cash in a savings account at a bank. However, doing so may result in a low return on your investment. Even if the equity market is down, you should employ your spare cash in the market for it to grow, as long as you have a healthy emergency fund in place.
Conclusion:
The saying “time in the market beats timing the market” contends that making regular investments in the market at consistent intervals outperforms making huge investments at the so-called “ideal” time. Placing your hard-earned money to good use during a down-market necessitates a long-term strategy and breaking away from the flock.
Furthermore, investing might become emotional if you are not equipped to understand the market or if you do not take any calculated risks. Investors need to understand the risk that they are incurring and should check if that is within their risk tolerance. In times of a downturn, sensible investors maintain a balanced and diversified portfolio across asset classes and geographies.
