Why we sell-off during market corrections?

Have we ever thought why most of us sell off our investments during market corrections? Is it because we need the money or is there any other reason(s).

We all must have taken a ride in the roller coaster; when it goes up we feel excited but feel scared when it goes down.  It’s the emotion of fear that the human brain is not trained to handle very effectively.

Our mind has one basic instinct to perform; to enable our body to survive. When we come across fear, initially the mind tries to overcome it but if it continues or magnitude of the fear increases, our mind will try and remove the cause of fear.

That’s exactly what happens when we go through the market corrections. As anything going down creates a sense of scare and feeling of fear, initially we try to cope up with it saying it’s just a minor correction and things would return to normal. But as correction deepens and market voices spread further negativity, our fear factor(losing more money) increases exponentially and that is the time when our mind finds it extremely difficult to cope up and will drive us to remove the cause of fear by selling off our investments. 

Once we have sold our investments and booked, otherwise, notional losses, we feel a sigh of relief. We no longer get affected by listening to all the negative voices as we have removed the cause of fear of losing more money.

So had we not seen the television or listened to negative voices of so-called experts during such correction times and held on to our conviction, we would have avoided distress selling and booking losses.

It is very important to understand that market corrections are temporary but growth is permanent. Market corrections are always followed by astounding returns. The best phase of the Indian stock market (Apr 2003 till Dec2007) has given 596% of returns in four and a half years despite having gone through several corrections en route. The graph shows it all.

courtesy : anchoredge

Conclusion

  • All previous corrections look like lost opportunity; Present correction is no different, Although it feels this time it’s different.
  • Market corrections are temporary; growth is permanent; Hold on to your investments until financial goal(s) is achieved. Switch yourself off from all market voices.
  • No one knows when the market would correct, how much will it correct and how long will it take to recover; but what matters is time spent in the market rather than trying to time the market. 90% of the gains in Sensex in the last 39 years have come only during 90 best days.

Need to discuss more, please feel free to book a no-charge consultation with me on this link: (https://calendly.com/rakeshgoyal)


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Understanding Investment Risks before Investing

Brutal fall in Indian stock markets over a period of last one month or so has left most of the equity portfolios bleeding. Fall has been so fast and vociferous that it wiped out almost all the gains of equity mutual fund schemes for last 3 to 5 years and in some cases up to 10 years. People who have started investing from 2018 onwards have their portfolios showing losses in the range of 20 to 50%.

This crash has left many investors wondering whether they were right investing in equity mutual funds?

During my interaction with investors, most of them ask “how much returns they are going to get on their investments?” Return on investments has no meaning by itself unless associated risk is taken into consideration. So the right question should be “how much risk is associated with my investments”. Understanding risk is important so that investors can take a informed decision before investing to get returns commensurate with risk.

Risk Capacity and Risk Tolerance 

More often than not, these words are used interchangeably but they have different meaning all together.

Risk Capacity. It’s the risk required to be taken by the investor to reach their financial goals. Your risk capacity is determined by comparing future cash flows to your investments( how much you expect to add or to withdraw from your investments) to your total value of investments . The more money you will be adding to your investments higher is your risk capacity.

Risk Tolerance. It’s defined as investor’s ability to absorb losses on investments. Low risk tolerance will make an equity investor sell equity investments at the very first instance of it going down whereas high risk tolerance means investor is willing to loose money and hold on to equity investments for potentially better returns. Following factors affect the risk tolerance
a. Time horizon for investments
b. Future earning capacity
c. Availability of other assets like house, pension, inheritance etc

So risk capacity and risk tolerance work together to determine the amount of risk required to be taken while planning investor’s portfolio. 

Investment decisions should ideally be guided by your risk capacity and not your risk tolerance, but often, it is the other way around. Risk return relationship is one of the fundamental laws of finance. You cannot get higher returns unless you take more risks.

The investor with low risk tolerance and high risk capacity needs to understand, that he or she may be compromising on their long term financial goals; on the other hand, an investor with high risk tolerance and low risk capacity needs to understand the potential implications on financial safety of their investments.

How much should be invested in Equity?

Rule of 100. 

Subtract the age of investor from 100, balance number suggests the maximum exposure of portfolio towards equity. e.g if the age of investor is 30 years, maximum 70% of his/her portfolio can be invested towards equities and for an investor of 60 years of age, 40% of his/her investments can go towards equities. These are average numbers and can be taken for planning purposes.

Rule of  Maximum Loss.
 
The Max Loss formula seeks to help investors determine the maximum percent of their portfolio that they should expose to equities. Max Loss depends on two factors:- What is the maximum percentage of your portfolio that you can tolerate losing in one year?What is the maximum percentage that you think the stock market can lose in one year?The formula of Max Loss % is as follows:

Max Loss %  =  (Max Portfolio Loss + Risk Free Returns) /
                            (Max Market Loss + Risk Free Returns)


Let us illustrate this with an example. Let us assume, you can afford to lose a maximum 5% of your portfolio value in a year and the maximum possible drop in the market in 1 year is 40%. The maximum percentage of portfolio loss should be worked out carefully based on your monthly cash-flows, your short term and long term liabilities and your average liquidity position in determining the maximum loss that you can tolerate.

In other words, if for some reason, you had to redeem your portfolio what is the maximum loss you can afford to bear. The maximum market loss should be based on how much the market fell on an average in bear markets. Let us further assume that you can get a risk free return of 6% (10 years GoI bond yield). The Max Loss % will be (5% + 6%) divided by (40% + 6%). When we do the math, we can have a Max Loss % of 24%. This should be equity allocation in your overall investment portfolio.

 Conclusion
1. Always invest in accordance with your financial goals.
2. Investors with low risk tolerance and high risk capacity should allot a portion of their investments in equity to meet their long term financial goals
3. One should always focus on the risks rather than expected returns. Expected returns are difficult to forecast.

Need to talk more on this? Please feel free to book a no-charge consultation with me on this link.(https://calendly.com/rakeshgoyal). Confidentiality is assured.


Goal Based Investments

With Nifty benchmark indices NIFTY 50 in correction mode for almost a month now, we are witnessing gains in our equity based portfolios getting eroded substantially, more so in mid and small cap. Nifty benchmark index has fallen almost 9% from its recent high and Mid & Small cap index has lost 28% and 44% respectively from their all time high made in Jan 2018.

Although it does create apprehensions and some sort of panic in the mind towards future outlook of our investments, it should not worry us especially if we are into Goal Based Investments. So what is this concept of Goal Based Investments?

When we begin our journey towards savings and investments, there has to be some future purpose of these investments, some events like Children’s Education, their Marriages, Retirement Planning etc which we want to finance in future by sacrificing our today’s spending. Let’s call these as future goals which we want to achieve through our investments over the available time horizon. Investment without a goal is like boarding a train without knowing the destination.

Hence Goal Based Investments allow us to invest towards achieving the desired goals in the available time horizon by choosing the correct asset allocation(equity, debt, mix of both, gold) with optimum risk through a Systematic Investment Plan.

A few of the behavioral and financial reasons for choosing goal based investments are :

1. Optimum Savings. Once the goals are decided well in advance, we know how much money needs to be saved regularly, nothing more nothing less.

2. Start Saving Early to get More. Sooner we start saving towards a goal, lesser savings would be required due to power of compounding. e.g If a child’s education requires 50 lac after 20 years, we need to save only Rs 5,500 pm if we start today as against an amount of Rs 10,600 pm if we start after 5 years  and Rs 22,500 pm if we start after 10 years (Assuming 12% return P.A.).

3. Tangible Outcome. We are more likely to save and invest towards achieving a definite goal rather than saving without a purpose.

4. Avoids Debt and Better Management of Assets and liabilities. By mapping tomorrow’s liabilities with assets of today, we avoid getting into debt trap. It also helps us in better budgeting thereby meaning how much we can afford to spend today as against how much we want to spend.

5. Optimum Returns. Goal based investment gives us the opportunity to match our time horizon with asset allocation by taking optimum risk. If there is a mismatch in allocation, we may save too much or too little, missing out on returns with conservative allocation or missing out on goals with too much of risk.

Goal based investments provide us with an opportunity to work towards achieving our future goals rather than chasing returns and give us  peace of mind during such turbulent and volatile market conditions.
Happy Investing!!