By P Saravanan and Sumit Banerjee
During market corrections, equity mutual fund investors wonder whether they should continue with their SIP or sell. However, investors need to take advantage of the bull market and also benefit from the bear market. Let us see what equity mutual fund holders can do during a market correction.
What is a correction and why does it happen?
Corrections are nothing but a moderate decline in the value of a market index or the price of an individual share. A correction usually means a 10-20% drop in value from the recent peak. Corrections can happen to any financial asset, including indices of stock market, commodity market or even shares of your favourite company. When the stock market rises continuously over an extended period, there comes a time when due to demand-supply imbalance a correction happens. The market always reacts to new information and a correction is an indication of a potential reset.
When markets correct swiftly, there are opportunities available outside the traditional investment avenues. For instance, investors with a higher risk appetite could probably consider investing in theme /sector based funds which could be more attractive after the fall. Generally, small-cap mutual funds become highly volatile in both bulls and bear scenarios whereas large-cap funds witness less volatility. Hence, you can increase or decrease your exposure accordingly. Once the market is reset, as a mutual fund investor you can increase your exposure in small-cap funds and decrease it in large-cap funds and gain maximum benefits when the market rebounds.
Keep cash to buy in dips
One of the essential elements in investment science is that you should have sufficient cash in hand to invest during market dips without touching the existing investment amount. When prices drop, equity mutual fund investors can take advantage of the situation by investing more each month to buy in at lower prices because prices always go back up eventually, so avoid pulling out money when prices drop. You can also consider cyclical sectors because during the volatile phase some of them may be hit hard and lower prices can offer a good investment opportunity for the long term.
Build a portfolio as per your risk tolerance
Make an equity mutual fund portfolio by adopting an appropriate asset allocation which fits your investment goals and risk tolerance, such that you can avoid any emotional investment decisions during a correction. New investors can probably understand what their risk tolerance is during corrections. If a market correction makes you think that you need to be more conservative, then wait for the market recovery before making any changes to your existing portfolio of equity mutual funds.
To conclude, correction in the financial markets is inevitable and usually correction is a short-term move ranging from a few weeks to months. Once the economic shock or geopolitical development that caused a correction runs its course, markets and securities generally recover and continue heading higher.
- Lower prices can offer a good investment opportunity for the long term.
- Keep sufficient cash in hand to invest during market dips.
- Investors with a higher risk appetite can go for theme/ sector based funds.
P Saravanan is a professor of finance and S Banerjee is a doctoral scholar at Indian Institute of Management, Tiruchirappalli.