By DK Aggarwal
When the bears take hold of the market, most investors either suffer significant losses or get shaken out of what eventually become profitable positions. We need to understand that bear markets are painful, but temporary. There are always market dislocations that can provide opportunities to enhance returns. In a bear market, stocks of both good and bad companies tend to go down. However, bad stocks are hit badly, while good stocks recover and get back on the growth track.
So, if the stock of a fundamentally sound company goes down, that presents a buying opportunity. Moreover, the current market correction is due to a pandemic, and it is beyond the control of investors, which is a systematic risk. It is both unpredictable and impossible to completely avoid. While it is not possible to avoid systematic risk altogether, it is always possible to reduce its impact by diversifying investments.
In this article we will try to talk about some best risk protection tools that can help us sail through, when there is a systematic as well as unsystematic risk.
Diversification: Investors should never put all their eggs (investments) in one basket (stocks), which is the central thesis on which the concept of diversification sits. The purpose of diversification is to reduce volatility and improve overall performance. Being well diversified can help cushion against losses. In every bear market, there are likely certain sectors and stocks that get hit much harder than others. It’s extremely difficult to forecast these ahead of time. So one preventive measure that investors can take now is to diversify within sectors.
Stick to fundamentals: Knowing and following the fundamentals takes much of the risk out of investing. There’s always some risk, but by sticking to sound investment strategies and planning out ways to cover the downside, the risk can be greatly reduced. The root of the current correction is not economic; the disturbance it will bring will play out the same out like the previous crises. We need to have patience. In times of uncertainty, fundamentally strong and sound companies sail through. We need to understand that better-managed companies will be able to withstand the turbulence and bounce back quickly. Investors are advised to stick to proven businesses now.
Stop losses:– A stop-loss limits an investor’s loss on a position when a stock makes an unfavourable move. Most importantly, a stop-loss allows decision making to be free from any emotional influence. This means stop-loss orders can help investors stay on track without clouding judgment with emotion.
Stay disciplined: Discipline in investing is about forming good habits and then doing them consistently. Discipline in investing should be maintained irrespective of market movements. A disciplined investment approach will help investors achieve long-term financial needs without depending on others. There should be nothing emotional about investing. Disciplined investors understand that the market is cyclical and there will be periods of growth and decline.
Don’t get overly protective: After seeing huge correction in the market, investors become ultra-cautious. However, rules say that we should not panic and avoid rash decisions. You need to remind yourself as to why you invested in those stocks. If the market is down, let’s say, 20 per cent in a month, it doesn’t mean it will all be lost in five more months.
The Bottom Line: Often the most successful investors are those who follow a proven investment process. The key is they choose an investment discipline and adhere to it. Each of these points we discussed in this article is an important tool that can protect investors from the inevitable volatility that exists in the investment world. Not all of them will suit all levels risk tolerance. But putting at least some of them into practice may help investors sail through such turmoil.
Chairman and MD, SMC Investments and Advisors