Aditya Birla Sun Life Mutual Fund

What do smart investors do in a falling market?

Dec 20, 2019
5 mins | Views 9356

Fear... is one of the most primitive and basic human emotions. Each and every one of us has probably faced some form and degree of fear in our lives. So how does one react when faced with fear?

A famous medical school physiologist propagated the ‘fight-or-flight response’ theory1 to explain fear and resultant human behaviour when faced with an imminent danger. As per this theory, when faced with fear, a series of chemical reactions are triggered in the brain which result in an emotional response prompting you to do whatever it takes to get away and keep you safe. Whether an individual run away or face and fight the fear is largely dependent on the emotional conditioning of the individual.

Imagine you are on a trek and you encounter a wild animal. What will you do? You will probably try to run away as fast as you can. This is the basic premise of fight-or-flight response theory.

This theory also emphasises that fear limits the human ability to act rationally and makes one act more instinctively which may or may not always be the best choice of action.

Fear responses often translate to investor behaviour

As an investor too, it is but natural that you may react in a similar way when faced with the fear of potential depletion of your investment values. After reaching an all-time high in June 2019, the Indian stock market has witnessed a steady fall, the SENSEX falling by nearly 4000 points till date.2

To illustrate, say you have an investment valued today at INR 1,00,000 in an equity fund. You wake up to markets opening in the red for a few consecutive days and realise your investment has now fallen to INR 95,000.

The fear of losing money can instinctively trigger a flight response to exit the market and liquidate your investment to avoid further fall in its value. While this may seem like the correct action at the time it may not in fact be beneficial for you as an investor in the long run.

It is widely accepted that markets are cyclical and what comes down today is likely to eventually come back up when markets pick up. An impulsive decision to flee the market may not only disturb your financial plan but may also prevent your portfolio to recover when the market picks up again.

So, what does a smart investor do differently in a falling market?

How do smart investors tide over bleak periods in the market? Smart investors tend to condition their mind differently to keep them from falling to their primitive emotion of fear and to instead act rationally yet cautiously. So, what can you do as an investor to emulate this:

  • Understand and accept that the market is cyclical

    The key is to understand and remember that stock markets are cyclical. The way a bull phase is followed by a bear phase, the bear phase will also eventually convert into a bull phase. Hold on, do not panic and give the market time to settle.

  • Do not obsess over tracking stock market indices every day

    Not every fall in price indices is an indication of a dipping market. This may just be a market correction to certain overvalued stocks. There may be different factors effecting your specific investments which should be considered before taking any impulsive investment decisions.

  • Do not value your investments every day or too frequently

    Equity investments require a reasonably long term to begin earning returns. A day on day comparison may show low or even negative returns but these may eventually balance out and convert into reasonable returns over a long term.

  • Focus on stock fundamentals of your investments

  • Focus on your financial goals

    Merely liquidating investments and keeping your savings idle not only keeps you from earning potential returns but may also get diverted and utilised for less important and unplanned purposes. Keep your eye on the prize – let your long-term goals take precedence over short term impulsive investment decisions.

  • Portfolio rebalancing

    A falling market could be a good time to check if your portfolio is truly diversified. If all your investments are taking a negative hit, you may want to relook at your asset allocation.

  • Avoid idling of funds

    Seek out beneficial investment opportunities even in times of a dipping market. Falling prices could be a good time to invest especially in case of undervalued stocks.

  • Seek the right assistance

    If you are unable to study the market or do not have adequate expertise and confidence to do so, seek professional help. Opt for any experienced financial advisor or portfolio manager to take over responsibility of your investment portfolio.

‘Wait, analyse and then act’ can be your investing mantra in a falling market. You needn’t be a fearless investor, but you could condition yourself to not allow fear of probable short-term loss cloud your judgement and keep you from potential future gains. Be in control of how you react to fear instead of letting fear control you and you can emerge as a smart and successful investor.

Sources:
1https://en.wikipedia.org/wiki/Fight-or-flight_response
2https://in.tradingview.com/chart/nRSvk8wK/

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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