Whether price dips are worth buying into depends on the reasons that led to such changes
Whether price dips are worth buying into depends on the reasons that led to such changes
When market tanks as it did recently, a question that most individuals want to know is whether to invest in shares and mutual funds on price declines.
In this article, we discuss how you should view price declines and why it is not the same as end-of-season sale for apparels and appliances.
Behavioural attitudes
Our brain lights up as a Christmas tree when we see discounts. If a product that retails for ₹10,000 is available for ₹2,000, our brain processes the information as a saving of ₹8,000, not as debit of ₹2,000!
Small wonder that individuals want to know whether to invest on price declines. The issue is that buying a product at a discount to its maximum retail price is different from buying stocks at a discount. Why?
You buy a product for personal consumption. The satisfaction you derive is based on perceived value, which increases with discounts.
Buying a stock or investing in a mutual fund on declines is different. You must sell your investments later to capture gains. That means the market must perceive greater value in those investments in the future. In addition to a company’s fundamentals, this is based on the collective behavioural attitude of market participants.
Also, there is the framing bias to consider — your perceived value depends on the reference point. If you believe that stock prices were reasonably priced before the market declined, then such price declines could open doors for bargain hunting.
But if you believe that the market was overpriced earlier, then a decline is a price correction to reasonable levels, not necessarily a bargain!
Market typically trends in one direction unless it is in a consolidation phase. So, when the market stops its uptrend and turns, how will you know whether it is a temporary respite for the bulls or whether the bears are in for a long haul?
Technical factors
This is important because if you buy on declines and the market continues to plumb new lows, you are likely to end up with losses, adding to unrealised losses you may have on your existing investments.
The typical advice is to buy on declines. But before you do that, consider whether you are investing to achieve a goal in the near term. If so, you may have to consider if the price is likely to bounce back to levels that will help you meet such near-term goals.
This factor is important because of the herd mentality among market participants. When the market declines, pessimism sets in. So, it is not surprising to see inflation or political uncertainty hitting the headlines, pushing prices even lower. Thus, whether price declines are worth buying into depends on the reasons that led to such price changes. If you continue to read that macroeconomic factors are likely to have an adverse impact on a home-country’s economy, then it is best to wait.
Conclusion
So, when should you buy price declines? The answer depends on two factors. One, do you have surplus cash? And two, are you willing to invest this cash without having to achieve a goal, or perhaps you want to accumulate money for the next generation without a definitive time horizon? If so, buying on declines could be meaningful.
If the market continues to decline, you have the time and the financial capacity to wait for the prices to recover.
Otherwise, it is best to stay away from such declines (note: you should continue your existing SIPs on your goal-based investments).
True, you would miss out on a rally in the stock market. But if the market goes south, you may end up with large losses. Remember, losses hurt more than gains give us happiness. Missing out on a rally will no doubt hurt. But buying a decline that continues to plumb new lows could be more stressful.
(The writer offers training programmes for individuals to manage their personal investments)
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