Stock markets have received heavy pounding over the past few weeks as escalating fears over the global economic outlook is pushing investors into safer assets like gold.
The stampede out of equities has spared few sectors or individual stocks and has wiped out hundreds of billions of dollars of market value across the world, including India.
This isn’t any banking or stock market crisis that we are facing. Neither it is anymore a government crisis.
Instead, what we are facing now is a ‘crisis of confidence’.
The US financial system looks completely out of control. European economies are also sputtering and sttuttering under the weight of possible government defaults.
In Asia, Japan is already broke. China is already fighting an overheated market. We in India are facing our own set of probems in the form of a slowing economy, and rampant corruption and inflation.
The governments don’t trust the financial markets, and the financial markets have lost all hope from governments.
So, all in all, a complete crisis of confidence has emerged.
This loss of confidence has led investors to shed their holdings in equities, and jump into either cash or gold.
Of course, the crash in the stock markets in recent times feels like an overreaction, but people aren’t going to view it as an overreaction until they have a reason to think otherwise.
So how do you invest in such uncertain times when the world is facing a crisis of confidence?
How do you invest in a world where returns on cash are so low, where bonds have become as volatile as stocks, where commodities surge and crash in a span of few days, and where stock markets have had the most catastrophic decade since the 1970s?
1. Don’t panic
This is the best thing you can do as an investor in these uncertain times. The most common mistake investors make in down markets is to react impulsively.
Selling at the bottom of the market cycle to get cash to put in other places usually results in a decreased return on investment over time. Riding through the bottom of the wave is usually smart.
An investor who thinks he can lock in his current portfolio returns by going to cash and then time himself back into stocks — what he ends up doing is destroy his ability to meet his long-term financial goals.
2. Pay down debt
Debt is a huge burden, and can lead to trouble if it goes beyond the repaying capacity. See what’s happening in the western world, where high debt of government and citizens has brought them to the risk of default.
If you have consumer debt – like an auto loan or a credit card loan – just pay that off before you invest your first rupee in stocks.
On such debt, you may be paying interest rates (of around 15-16%), which is at a much higher level than the rate at which you could invest in the stock markets (12-15%).
Paying off consumer loans and credit card balances is a really wise investment in a time when returns on other investment instruments may be uncertain.
In fact, you must look at investing in the stock markets only when you’ve paid of all of your debt, especially your high cost debt.
3. Review your allocation
Most investors are smart enough to know that they must spread their savings across asset classes like stocks, bonds, gold, and property. But there are few who review such an allocation from time to time.
At least annually, you should be looking not only at the status of your current investments, but also at the way you allocate new money across different asset classes.
While it is a good strategy for someone who has a 10-15 years investment horizon to allocate a larger part in equities, it pays to relook at your equity allocation when things go overboard (like in early 2008) or when they turn extremely bleak (like during the later part of 2008 and early 2009).
In the first scenario, you must reduce your equity exposure (be fearful as others are greedy), in the secoind scenario you must raise your allocation to equities (be greedy when others are fearful).
Only a consistent review will tell you what decisions you must take when faced with different situations.
4. Consider buying
Experience has shown that markets rebound and grow over time. The key question is your time horizon.
So if you are looking to invest for the long run (as long as 5-20 years), buying stocks near the bottom of the market (when the fear runs the highet) can be a good strategy. This is because a long term commitment gives you ample time to ride through the market volatility.
5. Go for the tried and tested
“There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can,” said Mark Twain.
Ironically, it is these very times when most people speculate – when they can afford (in bull markets) and when they can’t afford (in bear markets).
While speculating during good times seems normal, speculating during bad times is largely driven by the desperation to make up for earlier losses.
However, the best path for investors to travel in bad times is to stay with the ‘tried and tested’ companies – ones that have shown a long experience at weathering economic storms.
Avoid the temptation to make up any losses from speculation, by speculation.
The final word
When fear runs high, don’t run with it. Instead, keep a calm mind and be patient.
Patience is a great virtue in times when everything seems really bad.
Avoiding hasty decisions and riding through a downturn usually offers the best return over the long term.
Just stay the course and take advantage of the mad chaos you see around you.
Remember what a wise man once said, “Keep your head when all around you are losing theirs.”
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