Stocks suffered a brutal sell-off in March 2020 due to the coronavirus outbreak.
If there was one word to describe the sentiment of markets all around the world in the last eighteen months, it would be, absolutely crazy.
Okay, that’s two words. But that’s exactly what it is.
In a time where unemployment and inflation are worryingly high, stock market indices are having a dream run.
Gold, which is usually considered as a hedge during times of uncertainty and inflation, is now at pre-pandemic levels.
The precious metal, uncharacteristically, has taken a knock in an environment that should have boosted its prospects.
Cryptos, which are a relatively new asset class, quadruple in marketcap every time a tech billionaire (Elon Musk) tweets.
Commodities have also experienced a cocktail of price swings in the past year.
What started out with the price of oil futures turning negative for the first time in history in April 2020, has now flipped 180 degrees. Oil prices hit their highest levels since November 2014.
Even the price of natural gas has soared, with no relief for coal either. It climbed to record-highs leaving the country’s power sector to grapple with shortages.
Metals too have soared. Prices of steel, copper, and aluminium have reached astronomical highs, suggesting a supercycle of sorts.
So, what is going on?
Are we in a bull market? Are we in a bubble?
The truth is no one knows. But what we do know is that there are too many moving parts that at some point in time are going to start falling apart.
That’s a fact. We just don’t know when that will happen.
So, how does one ride this phase of volatility and come out unscathed?
It’s quite simple.
Imagine a cruise liner.
Something as large as an 80-storey building in length and a 20-storey building in width.
In the case of a cruise liner, even if most people gather on one side of the ship or the ship encounters bad weather, it won’t tip over.
You see, modern day cruise ships are surprisingly well prepared for all the bad weather one can expect out at sea. They’re designed to handle even the most severe storms.
Your portfolio should be able to do the same.
So how are the ships able to survive these storms?
Before construction, the naval architects make a ship scale model and put it through all kinds of extreme weather simulations.
This way they check how the future full-size vessel will react in any given situation.
However, there is one natural phenomenon that can still put this vessel at risk.
Rogue waves.
Just like volatility, they appear out of nowhere, and no one can predict when and where they will pop up.
Rogue waves are extremely rare, and chances that a cruise ship will meet one are really low.
For this purpose, cruise ships have long and narrow bows that help them cut through the waves more effectively.
They also have stabilisers that help them weather even more powerful storms.
This is exactly the approach you need to take to ride the volatility in the market.
So how do you do that?
Don’t panic.
Chances are that if your portfolio has been constructed with your risk appetite in mind, it should be strong enough to withstand market fluctuations.
Generally, investors whose risk and return objectives are conservative (with a larger allocation to bonds, fixed deposits, and gold) are much better placed to withstand market shocks. After all, they are diversified.
What if you are an aggressive investor, with a larger allocation to stocks?
If you choose to invest in companies that have strong fundamentals, then over the long term, you should be good.
Yes, there will be volatility which can be unnerving.
But as time has shown, fundamentally strong companies are the best way to wade through short term panicky situations, for potentially long-term gains.
Also note that panic can cut both ways.
It can scare you into selling too. And the ‘fear of missing out’ can force you into buying.
So, don’t sell because everyone is selling and don’t buy because everyone is buying.
Stocks suffered a brutal sell-off in March 2020 when investors dumped stocks on the fear that the coronavirus would disrupt global supply chains and damage the world economy significantly.
The Sensex fell 3,935 points or 13.1% while the Nifty fell 1,135 points or 12%.
However, the fall was short-lived.
Since then, markets are up over 150%.
If you were unfortunate to have got caught in the frenzy, chances are you would have made a big loss on your positions.
Hedge your portfolio and review it periodically
Investors who feel that they’ve taken on more risk than they can stomach in the face of volatility should consider hedging their portfolios.
To begin with, make sure you have a mix of investments that fit into your risk tolerance and time frame.
Your portfolio should broadly consist of four asset classes – stocks for prosperity, bonds for deflation, gold for inflation, and cash for recessions and depressions.
This will allow you to naturally hedge one asset class with another.
Once your allocation has been determined, stick with it.
And then reallocate your assets on a regular basis to keep the risk level the same.
This means that you could sell a portion of your investments that are performing well (sell high) to make investments that are currently not performing at their best (buy low).
You need not keep the allocation the same. It will evolve with your goals.
And, if you are a seasoned investor, assess the risk/reward situation that prevails in various asset classes.
For instance, in times of extreme chaos and uncertainty (the 2000s or 2008), it would be wise to allocate more money to safer assets classes such as cash and bonds and reduce exposure to riskier asset classes such as stocks.
Cash is king
Perhaps no other asset class elicits mixed feelings among investors as cash. In bull markets, cash is shunned. In bear markets, it’s embraced.
However, in a volatile environment, it’s one of the most important asset classes.
One of the ways to ensure that you don’t bear the brunt of a market crash is to make sure you have adequate cash reserves for a financial emergency that might arise.
That way you are not dependent on your portfolio for unforeseen expenses. You also don’t have to worry about liquidating your investments when they have declined in value.
Cash can also help you take advantage of attractive investment opportunities as they arise, especially in the case of a market correction or crash.
However, keep in mind, that while cash provides liquidity and stability, it’s not intended to be the primary holding within your investment portfolio.
Cash is particularly vulnerable in times of deflation and inflation. So, make sure you allocate wisely.
Invest for the long haul
One of the best ways of riding out market volatility is by cultivating a long-term mindset.
Also known as a buy and hold strategy, it basically means holding your investments for an extended period, often many years, to reap the rewards of capital appreciation, and compounding.
The strategy is based on the assumption that while there may be fluctuations in the market, it will generally produce returns in the long run.
It’s also one of the best and easiest ways to create wealth. You do not need any financial education if you just have the discipline to stay put.
Take the case of Ronald Read.
A janitor and gas station attendant in the United States, who died at 92 with a $8 million portfolio.
How did the humble janitor make so much money?
It turned out there was no secret.
Read saved up whatever he could and invested in blue-chip stocks. Then he waited for decades as his savings compounded into $8 million.
That’s it.
As most people know, it’s very difficult and risky to time the market. Many also panic when they see the market fall.
Staying invested in the market over the long term helps you avoid this emotional and financial rollercoaster.
Putting your money in long-term rather than short-term investments also provides tax advantages on capital gains.
Often long-term gains (those held over twelve months) are taxed at rates below your income tax bracket. Short-term gains, on the other hand, are taxed as regular income.
Long-term investing might also save you other expenses, such as transaction costs from active trading.
Take professional help
Properly managing your investments and making the right financial decisions take time, skill and effort.
It’s not a one-time thing, either.
You could consider whether you need a financial advisor or you could do it yourself.
Financial advisors can help you decide where, when and how you should invest.
They can also help ease your anxiety and remind you of your commitment to your allocation and financial goals.
However, no one knows you better than you. As you would for any important life-changing decision, you could take out the time to educate yourself.
You could also consult experts of different asset classes to help you make your decisions instead of assigning the entire responsibility to one person/entity.
In conclusion,
Winning a fight against rogue waves depends on having a well-maintained ship, a trained and experienced crew and a healthy dose of luck.
While it is difficult to account for luck, if you follow the above-mentioned steps, your portfolio should be able to withstand the turbulence like a sturdy cruise liner.
Preserving wealth is very different from creating it. It requires a mindset and discipline that focuses on avoiding huge losses.
This means that you might not get to participate in the next hot investment idea but you will definitely be able to grow your investments reliably in the long term.
Also remember that markets go through periods of high and low volatility regularly. It’s normal!
And higher volatility isn’t necessarily a bad thing. In fact, a small amount of volatility can actually mean greater profits.
As the prices of asset classes fluctuate, it provides an opportunity for investors to buy in at a low price and then wait for cumulative growth ahead.
So, don’t fear volatility. Befriend it.
You can’t get upside volatility without the downside, and over time, upside volatility tends to happen more often.
Embrace it.
(This article is syndicated from Equitymaster.com)
(This story has not been edited by NDTV staff and is auto-generated from a syndicated feed.)
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