Some people ask if it is a good time to invest when the markets are going down and some get worried when they are making new highs. It is a normal response to an uncertain future. But should you act on your feelings? Usually not. Here are a few things to keep in mind before you tinker around with your portfolio:
1. New all-time high vs Peak
A new all-time high means that it is at the highest level as compared to the past. A market peak also implies that prices will go down from there significantly. Your FD makes a new high every single day. Without that there wouldn’t be any growth. Stock markets generally have given returns of 12-14% per annum in the past - doubling every 5 years on average. For them to give these kind of returns, they will have to make a lot of new highs successively, which they do. As to whether a new high is a peak, no one can tell with any surety. Market peaks can only be known in hind-sight (like a lot of other things in life).
2. Markets make a lot of new all-time highs
Markets make a new high or are close to it (within 5%) almost a third of the time. Also, when markets make a new high, they end up going higher next day 60% of the times. Till they finally come to a peak which can’t be known before-hand. If one got out as soon as the market made a new high then one is likely to miss a lot of returns.
3. If you stop investing now, when will you start investing again?
The most important question to answer before you decide to pause your investing is when will you start investing again. When the market is 10% lower? 20% lower? Never? What if the market goes up by 20% and then comes down 10% - will you feel better about investing then?
Also, how long are you willing to wait for it to happen? 6 months, 1 year, 5 years? What if the market keeps going up for another year? Will you feel like a fool for missing out or will you stick to your gut-feelings and keep out?
Basically what all this boils down to is that do you have a system that will tell you when to stop and when to start? And how do you know your system works better than not doing anything?
Don’t stop something that you can’t start. :)
So what should you do?
Always invest according to your risk profile.
Your equity investments will go down 50-60% when the market crashes and you won’t be able to do anything about it.
Now decide how much should you invest in equity. Most people can tolerate a 20-30% loss without panicking in the event of a crash. In which case you should invest only half your money in equity (equity Mutual Funds or direct stocks) - the rest can be in debt (FD, Debt Mutual Funds).
If your current equity allocation is making you nervous that could mean you have taken more risk than you have tolerance for, in which case you can readjust your equity allocation and stick with it. Don’t go increasing it if suddenly you start feeling better about the stock market prospects.
Always think in terms of overall risk management rather than trying to time the market.
This post was first published by the author on India Infoline here.