The Upside of a Market Downturn: Opportunities for Smart Investors
You're thrilled about your investment decisions when you see your assets in green. However, sometimes the market turns for the worse, and your investments appear to bleed. You may be tempted to sell your holdings and cut your losses in such times. Except, you’d be making a huge mistake.
Yes, you read that right! You should keep your equity holdings in a downturn. In fact, you should go a step further by investing more in broad market indices.
Confused? Fret not.
Buying jackets in summers
Imagine that you are moving to a place where winters are freezing. When you move in April, you notice that the stores have winter clothes on sale. The prices are slashed low.
You know winters will come and buy them cheap. When winter rolls around, it isn’t as cold as usual, and you cannot use some of the jackets.
But the next year, winters are freezing and the jackets you bought come in handy. That is when you realise you made a wise investment!
Now, had you discarded the jackets that first winter because of an anomaly, you may have had to spend twice or thrice the amount to buy new warm clothes because their demand would have gone up, making them more expensive– That’s exactly what happens during a market downturn.
Companies that are actually valuable drop in price during a downturn, but their value remains the same. Investing in them, especially through index ETFs or Mutual funds, can yield higher returns in future.
But what exactly is a market downturn?
A market downturn is a phase during which the price of stocks declines for a continued period. For instance, if a group of companies in a sector make less profit in one quarter compared to the previous year, it would lead to a fall in prices and, subsequently, a decline in the market. The low prices could last from a few weeks to a few months. Multiple factors come into play during a downturn. We’ll explore them below.
Understanding downturns, crashes and recession
White technically, each of these terms may have specific definitions, but you know it only in hindsight. What seems like a minor downturn can continue to be a recession over several months.
But typically, if it's a news-driven market move, the markets recover quickly. However, if the market has been sluggish due to macroeconomic factors, such a downturn can take months and sometimes years to recover. But recover it does.
What goes down comes up
Even in the worst scenarios, when the stock market has fallen steeply, it has always recovered.
Take the example of the Great Financial Crisis of 2008 after the collapse of Lehman Brothers. The Indian stock market plummeted by 60%. By June 2009, it had recovered much of its losses and even turned a profit.
Similarly, in March 2020, the Nifty50 fell almost 40% to 7,511 from its January high of 12,430 because of the coronavirus pandemic. By January 2021, it was at 14,347, almost doubling in a matter of a year.
That’s why you should always stick to your investments when you intend to hold it for the long term.
If you have invested in well-diversified broad market indices, the negative impact of market crashes or downturns will likely be minimal on your portfolio.
Research indicates that the average decline of a bear market is 30%, while the average upturn of a bull market is 116%.
Why invest during a market downturn?
Now that we’ve established that holding your investments during a downturn is a good investment decision let's look at whether investing during a downturn makes even more sense.
1. You can buy more at lower prices
When markets crash, the unit costs of ETFs or Mutual funds also go down, it's a discount of sorts in the stock market, and if you buy when the markets are down, your investment tends to perform better when markets turn on the upside.
2. More return potential
The lower an index falls during a downturn, at least that much higher it can go up when markets recover. Rupee cost averaging, or reducing the cost of your total investment, makes it possible to pocket higher returns when the price recovers.
3. Limited risk
As an extension of the previous two points, investing during market downturns is actually less risky. The idea to keep in mind is that strong companies will perform well and grow in the right market conditions. During a downturn, the overall economy is down, leading to all companies underperforming.
4. Compounding returns
When you buy low, you are increasing your potential for compounding returns. As markets continue to grow over time, your investment value will also multiply. If you have an investment horizon of over 10 years, your investment amount will grow exponentially during that time frame.
Emotions & market downturns
Your emotional cycle is the biggest impediment to staying invested or making investments during market downturns. Watching your investments decline in value is never easy. It’s natural to get worked up, scared or panicked.
You may want to sell your holdings and cash in on whatever you can to protect your wealth. Moreover, you may notice that people around you are panic-selling in an attempt to preserve their own money.
However, the key is to remind yourself of your long-term goal and the history of stock market downturns. When you invest for the long term, short-term declines won’t impact your portfolio returns in the long run.
How to invest during market downturns?
Once you have overcome your urge to act on emotions and understand that market downturns don’t impact your long-term portfolio, you can consider investing to maximise rupee-cost averaging. Here are some tips for investing better during market downturns:
1. Do your research
All companies are not built equal. It’s best to stick to indices, which comprise the top companies by default.
2. Don’t try to time the market
There’s no way of knowing when the market has bottomed out. Instead, adopt a systematic approach to investing. Use historical data and market trends to understand how the market will move.
3. Take help
Don’t hesitate to seek help. You could talk to a financial advisor to rebalance your portfolio. Alternatively, you can invest in trading models to help you decide when and how to invest. For instance, if you are a beginner, you can use the Long India model hosted by Investmint App. The model is a step ahead of the usual monthly SIPs. Try it now!
Market downturns are part and parcel of stock market investing. Getting discouraged or selling in a panic can actually hurt your long-term wealth-creation potential.
Instead, learn about market downturns and learn to take advantage of them. They can be an excellent opportunity to widen your portfolio and improve your chances of return in the future.
Follow a long-term investment strategy and invest in diversified broad market indices like NIFTY50 or SENSEX. Take advantage of rupee-cost averaging.
Turn to systematic investing models, such as the ones provided by Investmint, to improve your investing technique during market downturns and enjoy the returns when the market turns positive.
To learn more about systematic trading and investing in the Indian markets, do follow us on Twitter.