Sensible Investing in Senseless Markets

Written By: Neeraj Chauhan, CFP

These are scary times for anyone trying to build or preserve their wealth. In today's roller-coaster ride of the market with economic ups and downs—the swings in the Sensex are enough to churn stomachs in all but the most steely-nerved passengers.

Is this simply another predictable, even healthy, correction in a long-term bull market? Or are we poised for an investor meltdown? No one knows for sure, of course. Even a modern-day Nostradamus couldn't tell us what will happen tomorrow. But no matter what, sticking to these six valuable investment senses will help you keep your head above today's troubled waters and sail smoothly.

Sense No. 1: Riding Over Market Fluctuations: Fluctuations in the market are a natural part of our economic cycle. Let's say the market is down; it might seem logical for some to cash out and go home. However, hypothetically, if one considers their long-term goals and the overall market outlook remains favorable until those goals are meant to be achieved, staying invested could be beneficial. Economic downturns are common, but crucially, you haven't lost money until you sell the security. With a favorable long-term outlook, the market is likely to recover, allowing investments to potentially regain and even surpass their previous values. This hypothetical scenario relies on understanding that the ebb and flow of the market are normal and should be viewed within the context of specific time horizons and financial circumstances.

Sense No. 2: Not Reacting to Daily Economic Reports or Media Commentary: In an effort to sell newspapers and air time, the media trains investors to look out for the next economic number of the day and give out all sorts of news. "Whether it's employment numbers, capacity utilization, or inflation statistics, there is always a number of the day to tempt investors into overreacting. In reality, it is nonsensical to react to daily economic reports and by the time you get the news, the market has already reacted. No investment strategy is better than identifying superior companies and holding them while letting your money compound over time.

Sense No. 3: Turning on Your Buying During a Downturn: Some of the world's most successful investors made their fortunes by buying when everyone else was selling. But that's not easy to do. Investing steadily during market downturns may be too much of a psychological adventure for most of us, but there is a system that enables almost anyone to take advantage of those tempting buying opportunities. It's called rupee-cost averaging. Rupee-cost averaging calls for investing a fixed amount each month or quarter on a specific investment or part of a portfolio, regardless of the ups and downs of the share or unit prices. By following this pattern consistently, you will purchase more shares when prices are low and fewer shares when prices are high. For example, if you decide to invest Rs 5000 each month on purchasing shares, you will buy only a few shares if the price is Rs 800 per share. If the price reduces slightly to Rs 600 the next month, the same money will buy more shares, keeping your outlook for the investment unchanged. This is a time-proven and effective way to minimize the effects of emotion in financial management.

Sense No. 4: Not Trying to Time the Market: It's better to invest regularly, without regard for the general condition of the economy or the direction of the stock market. "Timing the market, trying to determine the best time to buy specific stocks, rarely works." You might get lucky once in a while, but your luck isn't likely to last. Market timing and day trading realistically don’t work out for the long term. The financial press or stockbrokers make money from advertising and churning, and they do that by keeping you breathlessly chasing the latest tip. They make money whether you win or lose. Waiting for stocks to hit the 'bottom' before you buy or hit the 'top' before you sell has long since proven to be a losing game for investors. Select the stocks or mutual funds that you buy only based on sound fundamentals.

Sense No. 5: Maintaining an Appropriate Asset Allocation: If there is one point that virtually all financial advisers agree on, it's the critical need for you to maintain an asset allocation suitable to your circumstances. Asset allocation refers to the process of dividing your investable assets among various asset classes such as equity, bonds, gold, real estate, and cash. The diversification mix that is right for you at a given point in your life will depend on such things as your age, goals, and your risk tolerance. If your retirement is years away, most experts recommend relatively heavy investments in equities. "However, if your goal is in the near term, it's better to stay in safer assets like fixed income." Once you allocate your assets in the manner right for your circumstances, it's important to rebalance at least once a year. As the price of equities goes up or down, the ratio you have established will change. If the value of your equities has risen, you may want to sell off some of them to restore your original ratios. If their value has dropped, moving more cash into equities may be appropriate.

Sense No. 6: Following Your Investment Strategy: "Creating a plan such as rupee-cost averaging and sticking with it under all market conditions is the way to maximize your returns," Human nature makes it difficult for the average investor to stick to an investment strategy unaffected by emotion. Sometimes it's fear; sometimes it's pure greed. Either way, allowing emotions to affect your investing decisions is certain to damage your financial future. It's human nature to chase hot sectors that have already made a significant move. It's also natural to panic and sell out when everyone else is doing the same. While it may be the natural thing to do, it's not the smart thing. "It's important to have an investment strategy or financial plan and stick to it. Remember: If the headlines are full of it and everyone else is doing it, you're probably too late."

There is, of course, much more to the maintenance of an investment portfolio that may well help you sleep during these scary investment times. However, sticking with these common-sense fundamentals will go a long way toward achieving that end.

Happy Investing!

Edited By: Madhav Chauhan, CFA, CFP®