What to do with mutual fund investments during market volatility?

During volatile markets, many investors often panic and start to question their long-term investment strategy. Investors tend to get tempted to exit the market and wait on the sidelines until the market appears safe to dive into again. 

Importantly, market volatility is inevitable. It is the market’s nature to rise and fall over short periods. Timing your market investments could be tough in the face of volatility. One of the best solutions in such a scenario is to invest for a long period and avoid reacting to short-term market fluctuations. Herein, we discuss everything you need to know about market volatility and the measures you must implement to manage your mutual fund investments during volatile market conditions.

Market volatility is the rapid and unpredictable change in the market, which can increase or decrease the value of your investment portfolio. Higher the price fluctuation, the more volatile is the market. Generally, high market volatility is linked to a bearish phase or a downward moving market. This often occurs during times of economic stress or downturns, such as market contraction or recession. 

Price fluctuations in the market usually occur when the free-market forces of demand and supply are influenced by several factors, as follows.

A financial market is sensitive to economic downturns. The stronger the impact on the economy, the higher is the negative impact on market performance. Economic indicators and data, too, affect the market. For traders, economic data acts as a window to get an overview of the economy. When the economic condition is good, the market tends to react positively, and when the economy fails to reach its forecasted targets, the overall market might tumble. 

Inflation data, monthly job reports, and consumer spending figures affect the performance of the market. Traders generally try to predict various economic reports before they are published and buy or sell their market investments accordingly. If these reports deviate from the anticipated numbers, the market might fluctuate instantly. 

•    Changes in country’s economic policy 

Any changes in India’s monetary policy tend to cause sharp market movements. The market reacts positively when the Reserve Bank of India (RBI) eases the monetary policy, while it may react negatively when the financial body tightens the economic policy. 

The Indian economy is globally connected. This means that any event that occurs around the globe might impact India’s market. Regime changes, wars, revolutions, layoffs, and other such events are likely to affect trade, supply chains, investments between corporations and countries, and the flow of money. 

Politics is a key parameter that affects market performance. Governments tend to make informed decisions on parameters, such as taxes, trade agreements, and tariffs, that influence the stock market. Even speeches by leaders of political parties can cause market volatility. 

•    Public relations 

You might be surprised to know that volatility may not always be directly linked to the market. It may even be based on the public image of a company. A company’s stock performance also tends to be influenced by public relations hits and disasters. Moreover, the scale matters. The bigger an organization, the higher are the chances of its performance affecting the overall market.

Many mistakenly link market volatility to “investment risk.” However, market volatility is the anticipation of or response to the occurrence of a risk. Rapid changes in asset performance are caused by volatility. As an investor, you might think that you are losing money because of market volatility and be tempted to withdraw your investments under such conditions. This approach is harmful to your investment objectives because the funds’ performance might recover, and over time, the fund may generate high returns. As an outcome, if you are looking to generate high returns, you must remain invested in the mutual fund of your choice over the long term, that is, at least five to seven years. Here’s how you should react to market volatility. 

It is important to understand that market volatility is a part and parcel of your mutual fund investment journey. Note that a stable market situation is bound to become volatile at some point in time. Being aware of how to face market volatility is vital. When you start your mutual fund investment journey, you tend to plan your finances and allocations according to your financial goals, and you should not let any short-term hiccups in the market distract you from your goal.

 
Staying unperturbed and having an optimistic approach toward the market is the key. It may even make you understand that market volatility can, in fact, help you to purchase a higher number of quality mutual fund units at a discount, which you can later sell during bullish market phases for a profit. 

You can make volatile market conditions work for you. You may wonder, how? Consider formulating a proper asset allocation strategy. You must not place all your eggs in one basket. Instead, you must consider distinct investment options based on your risk appetite level, financial goals, and your goal’s investment horizon and invest in appropriate mutual fund schemes through SIPs. 

The full form of SIP is Systematic Investment Plan, which is a systematic and disciplined mode of investing in mutual funds. An SIP helps you to benefit from volatility. In simple words, the fundamental advantage of investing in a mutual fund through an SIP is rupee-cost averaging, which acts as a hedge against the risk of market movements. In other words, with SIPs, you can buy a higher number of mutual fund units during volatile market conditions. This approach allows you to average out your cost of investing in mutual funds.

It may be disappointing for you as an investor to see the value of your hard-earned money decrease because of market volatility. However, if you have not allocated your market investments based on your risk tolerance level, now is the correct time you should consider this measure. By taking this approach, you can prevent huge losses in your investment portfolio. 

When one of your investments does not perform well, the returns from another asset class may balance out your portfolio’s overall returns if you have implemented strategic asset allocation. You should review your investment portfolio periodically to rebalance it with the aim of maintaining your target asset allocation and remain invested in the market against all odds. 

 
An important approach you must follow is to be underweight on risk and overweight on quality in your investment portfolio, particularly when you have an equity-dominated portfolio. When the markets are bullish, you should focus on investing in small caps, mid-caps, thematic funds, and sector funds. Remember to never concentrate your portfolio heavily in any one small- or mid-cap equity fund because during volatile market conditions, your overall investment portfolio may register negative returns. 

 
Portfolio diversification is a crucial step that you must take to protect your investments during volatility. By allocating your money to different mutual fund categories, you can reduce your risk while still earning potential returns over the long term. 

Your investment portfolio must be designed strategically with allocation of funds across market capitalization levels and asset classes. As an outcome, your investment portfolio would be more stable and, potentially, yield higher risk-adjusted returns. In the case of equity-linked funds, large-cap mutual funds are highly stable and carry less risk compared to other types of equity funds such as small- and mid-cap funds. When your investment portfolio is adequately diversified, it is better placed to tackle volatile market conditions. 

Additionally, investing in low-cost index funds is an excellent step toward diversifying your investment portfolio and maximizing your returns while lowering your risk. Index funds tend to perform more consistently compared to actively managed mutual funds. Moreover, because indices are weighted depending on market capitalization instead of price movements, they are often less volatile, which makes them more suitable for risk-averse investors. 

Because equity funds are risky and volatile over the short term, assessing your investment portfolio periodically is crucial. This includes periodically adjusting the investment proportions of debt and equity in your portfolio to maintain the desired risk and return level. By evaluating your portfolio periodically, you can check whether your market investments are aligned with your financial goals. You must consider opting for portfolio rebalancing in the case of any underperformance in investment holdings or changes in your risk appetite. 

You must build your investment portfolio strategically, and you can do this only if you are aware of market trends. You must keep track of prevailing market events, internationally and domestically, because they can potentially impact your market investments. For instance, any change in government regulations and policies can affect specific industries, sectors, or companies, consequently affecting stock prices. Moreover, it is necessary that you remain informed about economic indicators such as unemployment rates, GDP growth rates, and inflation. Awareness about shifts in such metrics will allow you to understand how distinct sectors may perform, and you can adjust your investment portfolio accordingly.

If you are an SIP investor, you must continue with your investments in the market, irrespective of the market condition. Note that during a market downturn, you get the benefit of purchasing a higher number of units at a lower cost. When the market rises, you can liquidate these investments at a profit. Therefore, investing in mutual funds through an SIP is one of the best ways to remain disciplined with your market investments. An SIP facilitates periodic investment, thereby allowing you to average out your investment cost. 

Moreover, in volatile markets, you must try to top up your SIP investment to make the most of declining market conditions. This allows you to buy a higher number of quality mutual fund units at a lower cost, which you can sell later for a profit during bullish market phases.

Portfolio rebalancing is an important but often overlooked aspect of investing. It allows you to diversify your investments across distinct asset classes according to your requirements to generate the expected returns. When the markets fall, you can reduce the debt component of your investment portfolio and increase the equity component to avail quality equity units at a discount. Note that portfolio rebalancing must be an annual task or must be performed every time your desired asset allocation percentage changes. 

Volatility is inherent in the stock market. For this reason, ensure that you take calculated risks, do not panic, and make the most out of such market conditions by increasing your investments in equity funds instead of pausing or liquidating your market investments.

Source: Axismf Research
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