What should we learn from the Crisis?

We get panicked when we see that our whole life’s savings/investment reduces to half its value in a just a year. But yes this is also the reality and faced by many investors during 2008-09 crisis. The investors’ money reduced by almost 60% (assuming the money was invested in BSE Sensex) within January 2008 to March 2009 period.   It needs extra ordinary courage and patience to digest such kind of loss and remain invested. However those who continued for next two years they were back in profit  If we see the historical returns the market since has given approx. 10% average annual return if my holding period is more than five years. So what should we do where there is a bloodbath in the Dalal-Street and how to survive this kind of situations, lets us find it out.

  1.  The most important lesson we should learns from past crisis is that Stock Markets goes ups and down but will finally react to the underlying economic signals. It will recover back if the underlying economy grows. However the small retail investors typically buy when markets are high and sell when markets crash. We have seen it in 2008 crisis. The mantra is: Buy Right products and hold, don’t get into panic selling. Usually there is a sharp recovery after a crash which cannot be encashed by the immature investors except may be few experts and hence small investors are most likely to miss the recovery. Unless we are invested, we could not gain from the market recovery. The strategy should be holding a well-diversified portfolio (through diversified mutual funds) rather than just a few stocks.

  2.  The old saying “Never keep all the eggs in one basket” is always relevant especially in case of the investments.  In the past we have seen various themes like IT, Pharma, Infrastructure funds which have done exceptionally well for some time but also turned huge negative when the hype related to these sectors waned out. We need to diversify our assets in different asset class like equity, debt, gold, real estate etc., not just that within asset class also we need to diversify further like in case of equity we should spread our investments in Large, Mid & Small cap Diversified Funds, Sector funds have higher risk and should be limited to only a small portion of the total portfolio. Diversification is very important and while analysing the return part we should see the portfolio return rather than one particular class of the assets.

  3. Portfolio Rebalancing is another important thing need to be practiced in investments. Normally  when the market rises we get carried away with it and forget the prudence while increasing the allocation in that particular asset class, rebalancing has a purpose and should be practiced in a systematic way. First we should decide how much debt and equity we are comfortable with based on our risk appetite and financial goals.  Once it is decided it should be practiced and rebalancing should be done when one asset class goes up. For example if we have decided 50:50 as equity and debt and due to rise in equity market the portfolio moves to 65:35, in that situation we need to redeem the excess equity exposure and brought it back to originally decided allocation.  As we reach to our financial goals we should reduce exposure from high risk category to low risk category.  By rebalancing we also tend to book profits in between while reallocating the assets.

We have seen a very sharp growth in mutual fund investments in last two three years. These are those new investors who have not seen a long and deep market crash like in 2008-09. The points mentioned above are very important for those investor. If an investor has begun to invest just by looking at the past few years’ returns and don’t have a proper plan/strategy, he will panic and sell at the first whiff of a longer market crack. Panic selling and greed-based buying will costs much, not just money but also the trust in the markets. Hence it is always better to take proper guidance from an expert.