Across years, we have observed that investor’s behaviour changes as per the market sentiment. They turn risk averse when markets are going through a rough patch. On the contrary, they take more risk during the bullish phase. Exactly opposite behaviour is expected while investing in equities.
We wonder how investors make same mistakes time and again. Like they say, history never repeats but it rhymes.
In the recent times, Indian markets have been very generous. Corporate earnings haven’t kicked in and still equity returns are fantastic.
Recent investors believe that 15-16% CAGR is the minimum returns one can expect from equities irrespective of when one invests. This myth is spread by brokers and Mutual Funds who tend to highlight such high “returns” in their pitch for selling equity products rather than explaining other inherent advantages of equities. (Inflation beating returns, tax free, compounding returns to meet goals faster)
Many argue this time it’s different but history has shown us that markets reverse to match earnings growth rate. As markets have run ahead, it’s pretty clear the near term returns are going to be lower than the earnings growth rate. Given earnings growth rate would be in the range of 13-14% CAGR, markets returns could be lower than 8-9% over next 3 years.
This could probably be the worst time to invest in the market. One may argue not to sell out the already invested amount because timing doesn’t work. But it’s certainly a bad time for entering the market since expected returns are likely to be lower. Call it a coincidence, SIPs and retail participation has increased exactly in the recent times. Or is it because investors are victim of recency bias?
Many investors who had not invested a dime, or had a very small amount into equities, have started investing heavily into equities NOW. Most of them may feel cheated in near future. Add to it the market volatility which could lead to temporary loss on their capital that would lead to more disappointment. This sudden spurt in risk taking ability could definitely lead to a sad ending.
Dear reader, if your appetite for risk has increased off late, we would suggest you to be risk averse in these times. Yes you will miss near term returns but the real risk of market correction is still pretty much there.
It’s the time to hold on to your savings and be selectively into equities. Say if you wish to invest Rs. 10,000/month in equities, just invest 3,000-4,000 into equities. Rest can be parked into Liquid Funds or Fixed Deposits. If your invest horizon is well above 10 years, don’t chase high returns or risky products like Small Cap funds. You will get many opportunities in the future.
When markets will correct, don’t check the returns on existing portfolio but start investing as it goes down. Don’t wait for market to hit the bottom. As and when it falls to fair value, you may start allocating 100% into equities and move your existing liquid funds into equities as it corrects more. If you panic during that time, you miss the chance to make 13-15%+ tax-free compounding returns from equities. Our estimate of fair value today is around 8600-8900 on Nifty. As a thumb rule, if the Nifty were to correct below 9,000 over next 6 months, you may start investing into equities. Always buy a basket of stocks across large, mid and small caps. (Our fair value estimates change every six months.)
Now that you are aware of equities, always remember, time to take risk is when markets are cheap. Time to be risk averse is when markets are cheerful.
Happy Investing and Happy Diwali!