Have you invested a lot of money into stocks? 4 tips to manage stock market volatility Many of them are new investors who have not been through a bear phase and do not have the temperament to withstand losses. They are investing after being bitten by the FOMO bug or swayed by finfluencers on social media. If you have taken too much risks, here is why you need to remain cautious
If the market corrects, will you buy or sell? Three out of five respondents to a dipstick survey conducted by ET Wealth in mid-October said they will invest more to gain from lower prices. But when the markets actually fell the following week, many of them retreated into a shell, forgetting the golden rule that extols them to ‘buy when there is blood on the street’. This say-do gap might cost them an opportunity, but many retail investors could possibly be making bigger mistakes. Spurred by the stock market rally in the past two years, they have poured money into equities without adequately considering the risks involved.Many of them are new investors who have not been through a bear phase and do not have the temperament to withstand losses. They are investing after being bitten by the FOMO bug or swayed by finfluencers on social media. “Even people who have never invested in stocks are ready to jump in,” says Deepti Goel, Associate Partner in financial advisory firm Alpha Capital. “They have changed their equity allocation thermostat from zero to high,” she adds. Last month’s correction was a wake-up call for investors who may have taken more risks than they can digest.
Though equities have the potential to deliver high returns over the long term, the allocation should not exceed the risk tolerance of the individual. Allocating more than 60% of your portfolio to stocks can yield handsome returns, but do this only if you can tolerate a 20-25% loss (see graphic). Investors must also temper their expectations of returns from this asset class. Earning reasonable returns from stock investments is easier than one would think. A simple portfolio comprising bluechip stocks and a mix of equity funds can easily deliver 12% annualised returns over the long term. At the same time, earning unreasonable returns of more than 25-30% is more difficult than you think.
DEEPTI GOEL
ASSOCIATE PARTNER,ALPHA CAPITAL
Note: “Even people who have never invested in stocks are ready to jump in. They have changed their equity allocation thermostat from zero to high.”
One would have to allocate more to equities and invest in riskier instruments to earn that kind of return. Newcomers who started investing in stocks only recently and have earned phenomenal gains may not be convinced. They expect the markets to continue their upward march. Many of them are also dabbling in the high-risk derivatives segment. Meet Rajeev Kumar (see picture), a software professional who has made close to Rs.2 lakh from stock trading in the past two years. Kumar buys and sells stocks very frequently using a mobile trading app and has positions in almost 12 scrips. “The app alerts me about stocks to buy and sell, helping me generate handsome returns,” he says.
Rajeev Kumar
28, Pune
Note: Though this software professional invests randomly, he has made good gains in the past two years. He also dabbles in option trading, but has not been very successful. Rajeev does not follow any asset allocation and relies on social media for information on stock markets.Six months ago, he entered the F&O segment after seeing social media posts about option trading. However, his foray into index options has not been very profitable. Still, Kumar expects to eventually learn the ropes and make money. Experts believe investors such as Kumar are set up for failure. “These new investors will learn their lessons the hard way. Newcomers always give tuition fees to the markets,” says Abhishek Gupta, Founder and CEO of Mumbai-based wealth advisory and PMS firm Moat Wealth Associates.
Your risk-reward barometer
Your return expectations should match your equity allocation and ability to withstand losses.
Reduce small-cap exposure
Choosing less volatile stocks and funds is one way to cut the portfolio risk. The small- and mid-cap segments have generated the highest returns and also witnessed huge inflows in the past year. However, these stocks are more volatile than large caps (see graphic). We must put in a caveat here. Volatility should not be confused with risk. It is only an indication of how much the price fluctuates over time. The real risk is when volatility pushes an investor to turn a notional loss into a permanent one (see story on page 6). As it turns out, new investors are more vulnerable to committing behavioural errors triggered by volatility.
Concentration vs diversification
The five worst performing Nifty stocks and funds in the past year.
Note: Adiversified portfolio is less risky than individual stocksThey have not been through a bear phase before and don’t have the temperament to withstand losses. They suffer from acute seasickness when markets turn choppy and usually make mistakes that turn notional losses into permanent ones. Vishnu Mangal (see picture) rues his decision to sell AU Small Finance Bank shares when the scrip declined sharply two years ago. The share price has risen almost 50% after he sold at Rs.430. “The steep fall in the share price unnerved me. I missed the opportunity to earn good returns,” he says glumly.
Vishnu Mangal
42, Kota
Note: He has been investing in stocks for several years, but has not fixed the asset allocation for his portfolio. Mangal had planned to invest more if the markets corrected, but is now hesitating to commit more money to stocks.Gupta of Moat Wealth Associates has a simple solution. Don’t invest in small and mid caps directly but take the mutual fund route. “Retail investors are more likely to make mistakes in picking small- and mid-cap stocks. It’s better to rely on the expertise of the fund manager in these segments,” he says. Even experts have turned wary about the small-cap segment. “We are not negative on small-cap stocks, but we don’t want the fund manager to be pushed into committing mistakes,” says Rahul Singh, CIO of Tata Mutual Fund. Two months ago, the fund house stopped accepting lump-sum investments for its small-cap scheme.
Several other fund houses have done the same. “When the AUM of a small-cap fund becomes too large, it can become difficult for the fund manager to deploy funds. That’s why fund houses stop accepting lumpsum investments, though they might continue with SIPs,” explains Arnav Pandya, Founder of MoneyEduSchool. Experts say the allocation to small and mid caps should not be more 25-30% of the portfolio. “Large-cap stocks are more stable. They should form the core of the average retail investor’s portfolio,” says Kamal Rampuria, Senior Vice-President of AUM Capital.
Diversify for stable returns
The benefits of diversification are well known. A concentrated portfolio can deliver outsized returns but will carry more risk than a diversified basket. Who knows this better than investors in the Adani group stocks after the Hindenburg report came out in January this year. Within a span of a few days, Adani group shares, including the flagship Adani Enterprises, which is also a Nifty constituent, had slipped 60-70%.
ABHISHEK GUPTA
FOUNDER AND CEO,MOAT WEALTH ASSOCIATESNote: “The new investors who started investing in stocks 1-2 years ago will learn the hard way. Newcomers will always give tuition fees to the markets.”
We examined the performance of mutual funds and individual shares in the past year. The five worst performing Nifty shares dropped by an average 18% in the past year, even though the index rose by 7%. Mind you, these are not obscure penny stocks, but constituents of the Nifty 50 index. During the same period, the worst performing flexi-cap equity funds delivered low but positive returns for investors. “Some investors have a mindset against mutual funds. They don’t want to give up control, even though they can’t outperform the fund manager,” says Goel. For these investors, the choice is between earning better returns by entrusting their money to a mutual fund or investing on their own and losing money.
The risk in stock investing is not only from poor stock selection but also short tenures. If equities are held for the long term, the possibility of losses comes down significantly. This may not apply to individual shares, but is certainly true for equity funds. In fact, a Crisil study shows that instances of losses are nil if SIPs in equity funds are continued beyond five years. If you don’t need the money for the next 5-6 years, don’t hesitate to invest in equity funds through the SIP route. Answer the questions on the left to know if you should be selling your stocks now.
Rebalancing the portfolio
Have you also taken more risk than you can handle? One way to control risk is by rebalancing the portfolio and restoring the original asset allocation. Backtesting studies have shown that investors who regularly rebalance their portfolios and stick to a predetermined asset allocation tend to do better than investors who keep their portfolios static and let them flow with the market. “This, in turn, helps in boosting the investor’s confidence. When the markets tumble, a rebalanced investor is less likely to panic and more likely to remain invested,” says Raj Khosla, Managing Director of MyMoneyMantra.
RAJ KHOSLA
MANAGING DIRECTOR,MYMONEYMANTRA
Note: “Rebalancing helps in boosting the investor’s confidence. When the markets dip, a rebalanced investor is less likely to panic and more likely to remain invested.”
NEHAL MOTA
CO-FOUNDER AND CEO, FINNOVATE
Note: “Volatility is not risk. It is simply the fluctuation in stock prices. The real risk lies in turning a notional loss into a permanent one.”
It is advisable to rebalance the portfolio at least once a year, preferably at the end of the financial year or after a big change in asset prices. Disciplined investors who rebalanced their investments when the Nifty crossed 20,000 in September would not have been as badly hurt by the downturn in October. In fact, they can now buy back the stocks at lower prices. One such investor is Amit Maheshwari (see picture). Though he is bullish on equities and has built a sizeable portfolio by investing small amounts in stocks and equity funds, Maheshwari regularly books profits to ensure that his allocation to this volatile asset class does not exceed 60%. When markets decline, he is ready with dry powder so that his equity allocation doesn’t fall below 40%. “Regular profit booking helps me rebalance and control the risk in the portfolio,” he says.
Amit Maheshwari
50, Delhi
Note: This former IT engineer is bullish on equities and invests regularly in stocks and equity funds. At the same time, he ensures that his equity allocation is within 40-60% of his investment portfolio. The recent downturn has hurt his portfolio, but Maheshwari is not worried.Use F&O to hedge
If you have a significantly large equity portfolio, you should consider using derivatives to hedge the portfolio. Buying put options can cushion your portfolio against a drop in the stock market. A Nifty put of strike price 19,000 and expiring on 28 December is currently quoting at Rs.192. The cost of one lot of 50 shares will be Rs.9,600. If the index crashes to 18,500 by that date, the buyer gains Rs.308 (or Rs.15,400 per lot). However, if the index doesn’t fall below 19,000, the option expires at zero. Consult a qualified investment adviser to know the best strategy to hedge your portfolio using derivatives.
Derivatives can cushion your portfolio
Here’s how much Nifty puts of different strike prices will yield.
Unfortunately, most participants in the F&O segment don’t use options to hedge their portfolios, but for speculation. Trading in derivatives has increased by leaps and bounds in the past five years, rising from Rs.8.5 lakh crore in 2018-19 to Rs.108 lakh crore in 2022-23 on the NSE alone. The average daily premium turnover of index and stock options is Rs.46,377 crore on the NSE. No wonder stock exchanges want to extend trading hours for derivatives. Don’t let finfluencers charm you into buying options and earning high returns. In most cases, they are touting misleading figures and unverified claims. Only last week, Sebi banned three such influencers from selling their trading course and asked them to return the fee they had collected from investors. Think of it this way: If anyone can accurately predict the market movements, he can make crores of rupees and it won’t be necessary for him to sell trading courses to others for Rs.5,000-6,000.
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This story originally appeared on: India Times - Author:Faqs of Insurances
