Surviving Market Meltdowns: Lessons from the Sensex Fall

What key strategies can investors use to stay calm and avoid panic selling during a market meltdown?

One thing that works very well for any investor - especially new investors - is developing resilience. If you've been in the market for five to seven years, you might have got used to it. But if you haven't, even for experienced investors, it's difficult to cope if you've accidentally drifted into the market. For example, many investors entered the market because they saw their neighbour or friend making money.

First and foremost, align your investments with long-term goals if you're investing in equity.

Second, for new investors, choosing the right vehicle is crucial. Most people get attracted to sectoral or thematic funds, funds that performed exceptionally well. While these can be enticing, they aren't always the best way to start. For those investors, starting with an aggressive hybrid fund might be a more palatable approach to benefit from the market.

Third, learning a bit about how things work - investing in quality funds and understanding the basics - can help. You don't need to know everything, just the fundamentals.

Fourth, if you're a relatively new investor, don't watch the market every day. New investors often get curious, especially when the market is doing well. But watching daily movements can tempt you to uproot your investments. Instead, focus on the long term.

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What do historical Sensex recoveries teach us, and why is staying invested critical for long-term success?

When I look at major market falls, the biggest ones happened before critical economic changes. For example, between 1986 and 1988, the market declined by 40 per cent. This was a time when India was nearing bankruptcy, and the government had to mortgage gold to borrow money.

After that period came the great Indian reforms of 1990, followed by the 1992 scam. If you look at 1990-91, the market declined further by about 35 per cent. It has taken anywhere from two to three years for the market to regain its previous value. In good times, the recovery is faster, like during COVID, when markets bounced back in eight months.

Over the past 45 years, the worst-case scenario for recovery has been within three to four years. While you can't extrapolate past trends to predict the future, one consistent lesson is that you need time and patience. The key is to keep buying when the market is cheap.

Suggested read: Not just the day's numbers

How can investors balance risk and opportunity during a downturn, and what role does asset allocation play in surviving market volatility?

Asset allocation becomes even more important during a downturn. If you have a sizable amount invested in equity and might need it for consumption, regrets can be amplified. To reduce this, allocate a portion to fixed income. This ensures liquidity when you need it and protects you from being fully exposed to market risks.

Even if you don't need the money, having a preset asset allocation (say, 20-30 per cent exposure to fixed income) allows you to take advantage of market downturns by buying when prices are low. Periodic rebalancing can also help.

For newer investors, starting with an aggressive hybrid fund can offer a steadier introduction to the market. But if you're investing for the long term, view downturns as opportunities to buy assets cheaply.

Suggested read: Real, practical asset allocation

Viewer's Question

If all funds are doing well (3 to 5-star-rated), how does having too many funds translate into a higher expense ratio and lower returns? -Jeewan Dabra

No, having many funds doesn't directly increase the expense ratio. Expenses depend on the size of the fund. Larger funds, such as those managing Rs 40,000 crore, typically have lower expense ratios.

However, the real issue with having too many funds isn't expenses—it's dilution. With 10-20 funds, you end up with overlapping portfolios, essentially creating an index. Some funds perform well, and some don't, but the overall effect is less impactful.

Additionally, having too many funds can make you disengaged. When each fund accounts for only 5 per cent of your portfolio, you're less likely to review performance or make tough decisions, like exiting poorly performing funds.

A focused portfolio of one to five funds can offer sufficient diversification and help you stay actively involved in monitoring and optimising your investments.

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Also read: Diversification can be a dummy exercise. So, check this for best result.

This article was originally published on November 22, 2024.