When stock prices are in a free fall, you'll find many experts warning investors to 'stay on the sidelines' and 'wait out the volatile phase'. Often, this is accompanied by advice not to 'catch a falling knife'. This advice may fit traders very well, but it can mean the death of wealth creation for long-term investors.
It makes sense to 'wait out a volatile phase', provided you know exactly when the 'volatile phase' will be over and done with and the next secular uptrend is set to begin. But the reality is that no expert is able to flag the exact time when a market bottom has been made and the stage is set for a new bull market. Market bottoms are always evident only in hindsight.
Therefore, if you sell your equity funds or stop your SIPs during market falls (especially after an official bear market is announced) in the hope of 'waiting it out', there's a pretty good chance you will not know when to re-enter equities or resume your SIPs. If you wait too long for stability, there's a good chance of missing out on the next bull run. Even missing a few months in the initial part of a new bull market can really decimate your long-term returns.
If this sounds alarmist, just consider this hypothetical story. Consider Mr Hasmukh who parked ₹1 lakh in the BSE Sensex in January 2000 15 years ago. Had he just bought a Sensex ETF and slept on his investment till date, his original capital of ₹1 lakh would have grown to ₹4.66 lakh, an effective CAGR of 10.8 per cent over a 15-year period.
Now consider his brother Mr Chintamani - an investor who checks on his portfolio every month and tunes in to all market experts. He doesn't believe it is wise to catch a falling knife. Therefore, he is in the practice of 'booking out' of his ETF every time there's an official bear market. In the last 15 years, whenever the Sensex fell by 20 per cent, he would immediately cash out on his equity portfolio and wait it out for the next nine months for the volatility to subside before re-entering equities.
As the Sensex has fallen by 20 per cent or more on eight occasions in the last 15 years, Mr Chintamani would have thus had to exit his ETF and re-invest in it eight times each in 15 years.
So how much money would Mr Chintamani have made through this start-stop approach to investing? You'll be surprised to know it would barely match the savings bank interest of 4 per cent. That's far inferior to that of his brother Hasmukh and 6.8 per cent a year lost to 'smart' market timing. Returns apart, imagine all the sleepless nights he would have spent deciding when to sell and when to buy his ETF!
But wait, how did this happen? How come long-term investing didn't pay for Mr Chintamani even after holding equities for 15 years? The answer lies in the fact that in stock markets - just as bear phases tend to be unpredictable and intense, robbing you of a great deal of your wealth in just a few weeks - bull phases tend to be unexpected and rapid fire too. In fact some of the biggest monthly gains put on by the Sensex in the last 15 years have come within six-nine months of a record market fall (see Figure 1).
Mr Chintamani's returns are so anaemic because while waiting out the volatile phases after market falls, he has also been forced to sit out the sharp rallies that marked the beginning of the next big bull run. Getting psyched by the 27 per cent fall of May 2004, for instance, and staying away until February 2005 would have caused him to miss out on 40 percentage points of the 60 per cent gains put on by the Sensex between May 2004 and July 2005.
Or his running for cover in March 2008 would have kept him out of the market until April 2009, which is when markets began to settle down. This would have meant missing out on the record lows of sub-8,000 for the Sensex in October 2008.
This just goes to show that exiting equities after a market fall is the easiest thing to do. Getting back into equities at the right time is the hard part. If you dilly-dally too much, the bus will leave you far behind.
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