Volatility in the investment world means unpredictable and sharp stock price movement. People often relate market volatility with a sharp price decrease; however, stock market volatility can refer to sudden price rises too.
The India Volatility Index (India VIX) is an indicator to track the volatility in the Indian stock market. If the VIX value is less than 18, it means that the bulls are in control and the markets are stable and less volatile.
If the stock market volatility exceeds levels 18 or 20, then that indicates potential uncertainty in the stock market, and it could mean the entry of bears into the market.
Asset Allocation
Coming to the right asset allocation strategy in volatile markets, it is safer to go with defensives. Typically, whenever there is a Tsunami, the first ones to drown are the small shops on the beach, whereas the storm does not impact high-rise complexes as much.
Similarly, companies with a long successful track record are the ones that would outperform (take minor hits) because of the recent correction. Small-cap stocks and mid-cap stocks are considered high-risk and volatile. As these companies do not have a lot of data behind them, they are the first ones any investor will give up.
You can also evaluate the option to invest in Defensive stocks. Defensive stocks are companies that provide regular stable dividends and have been performing well, over the last couple of decades or more. Companies like Asian paints, HUL, Colgate, etc. are typically considered defensive stocks as these companies had stable earnings year on year for the last few decades irrespective of a negative market outlook.
It would be best if you focused on allocating more than 50-60percent of your capital to large-cap stocks whereas 15-20 percent each can be assigned to small-cap and mid-cap stocks.
For mutual fund investors, evaluating the option of investing in multi-cap and Flexi-cap funds would work better. These funds generally give you a better edge in terms of risk to small and mid-cap stocks. Market turbulence can be a stressful event for investors.
Here are four things you can do when stock market volatility makes the markets move down
1. Do not panic and sell your portfolio
The most important thing for you should be to not panic. We have seen that retail investors sell their portfolios whenever the market becomes volatile. The average time frame of a bear market is about ~9 months which is significantly shorter than the average length of a bull market which is almost 2.7 years.
This time will pass too.
2. Take the long-term view
After every bear market, there is an even longer and stronger bull market. Bear markets are very important for any market to sustain, survive, and go to higher levels in the future. Considering three-year views of the stock market, you will make money in the stock markets with the right stocks, discipline, and patience.
Although some investors can be pessimistic during such times, most investors typically are highly optimistic and bullish on the stock market. The stock market has tended to give positive returns over decently long-time horizons.
3. Review the portfolio allocation
Risk tolerance is the willingness to take risks whereas risk capacity is the ability to take the risk.
The former depends on your emotional capability to handle and see losses in your portfolio, without panicking and taking inappropriate action. However, the latter is the actual loss-taking ability i.e., financial ability.
Market downturns are the perfect time to revisit and review the risk levels in the portfolio and make the right changes. You must answer your problems around immediate liquidity needs. What if your portfolio goes down further by 10 percent how it will affect your overall financial plan?
If you need the money soon, you may want to pull it out of the volatile markets because you cannot afford to lose that amount.
4. Rebalance your portfolio
Stock Market volatility can reflect your decision-making in the past. You will understand whether the portfolio was diversified well or not. Defensive stocks in the stock market are a perfect fit in such times of volatility. These stocks are least affected when the overall market sentiment is negative. Because of the recent correction in the stock market, your portfolio would have diverged significantly from the target allocation mix.
Such times are perfect to reconsider moving towards your target allocation mix of small-caps, mid-caps, and large-cap stocks.
Volatility is like entering into the deep sea. You don’t know what the next wave will bring in. You cannot plan for the next move. The only thing you can do is pilot a large ship or a cruise than go in a small boat. It is safer to go equipped with a cruise that can handle the irrational behavior of the sea.
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Read more: How Long term investing helps create life-changing wealth – TOI