It is going to be 10 years on 21 January 2018, a decade, since the 2008 stock market crash. The BSE Sensex had registered a fall of 1408 points, the second largest single-day fall in the history of the Indian stock markets. History in hindsight always offers valuable lessons. While investors can never fully anticipate and prepare in advance for future crashes, such events do teach a thing or two about managing risks. Here are a few lessons which investors can always bear in mind to face mayhem and bloodbath on Dalal Street:
Diversify your portfolio
An investment portfolio concentrated more towards direct equities is highly risky. It is prudent to spread your risk and diversify your portfolio across other asset classes like fixed income (deposits, small saving schemes), gold, etc. Different asset classes move in different directions and are negatively correlated. The value of some assets will move up at a certain time while others will go down in the same period. A well-diversified portfolio will thus be able to weather the storm effectively and restrict your losses.
Rebalance your portfolio
When the equity portion in your total portfolio goes up beyond the stipulated extent, rebalance your portfolio at regular intervals and sell a portion of the equity component. Regular rebalancing will automatically take care of the market volatility. The question of ‘when to sell’ will not arise, even during a crash as you would have already done that through rebalancing. Rather than a victim, you will be able to take advantage of volatility in the event of a crash. The cash in the form of booked profits can be used to buy the right stocks at a battered and bargain price in the midst of a storm.
Do not sell all equity holdings
It is important to have some equity holding in total portfolio irrespective of market conditions as equity is meant for the long term and the best asset class to beat inflation. The best way to stay invested in equities all the time is through equity mutual funds. These are less volatile than direct equities. They can be mapped to your long term financial goals. These can be redeemed only when you need the money for your goals such as retirement, child education, etc.
Take expert forecasts with a pinch of salt
At some point of time, every investor is consumed by the same sentiment, thanks to the herd behaviour in the stock markets. Experts forecasting the economy and the markets also play their part here. If there is a general bullish sentiment, the experts talk all good about the economy and the markets. If there is a bearish sentiment, these same experts will paint a dreary picture as if the world is going to end. Take the case of digital currency (cryptocurrencies) which are predicted to be the next big thing or the Sensex forecast of 40,000 in anticipation of the current government regaining power in the 2019 elections. Experts have a prediction for everything. But if you look at history, 99 per cent of these experts, even people in prominent government positions and the best economic minds were unable to predict the dotcom bubble, the housing crisis (real estate prices do not crash, showed past predictions). Had they been able to foresee these events, they could have been avoided in the first place. So, bear in mind that no expert has a crystal ball to predict the markets. Do not take their predictions at face value while taking any investment decision.
Expect the Unexpected
As Mark Twain states – ‘History does not repeat itself but it rhymes’. The reasons behind each crash may be similar but circumstances are different. It could broadly be poor regulation or too much money chasing few assets to create a bubble. But no one, even with the benefit of hindsight, can formulate an accurate hypothesis as to why market crashes happen when they happen. A former Wall Street Trader and renowned author Naseem Taleb popularised the term ‘Black Swan’ as an event which is rare and hard to predict but will inevitably happen at one point of time. This theory is very useful for stock market investors, especially the ones who become complacent or greedy. Such investors, consumed by the wave of optimism and blinded to the downside risks take on more exposure to the markets when they are rising. Further, there is a common phenomenon of retail investors typically joining the stock market euphoria right at the peak of a bull run. So, understand that the stock market is risky and odds are that severe corrections will occur in the future.
To conclude, rampant speculation and volatility is inevitable in the markets. A bit of self-discipline and patience is required to manage the risks, especially during a downturn. As a popular saying goes in stock investing – ‘While bad traders chase profits, good traders manage risks!’