Sit tight when the market is in fright

The markets have crashed because of a combination of local and external events. Statements by the Left are making investors nervous while external events — like oil prices and the continuing violence in Iraq — are making matters worse.

But remember this. Every book on capital markets says that a market crash is the worst time to sell. And yet that is what most small investors still do. We point out the reality to you here again: we are in a market crash situation and these typically don’t last very long if the fundamentals of an economy are strong.

The average annual return from the stock market over 1979 to 2003 (even before the 2003 bull run) has been a healthy 15 per cent. But to get these returns you need to have the stomach to hold on in a crashing market. Nobody can predict where the market will go in the next week, but the overall annual direction is not in doubt. Even now.

What should you do? There are several choices:

• For the very short term, for those who are not in the market, stay out. This is the time for the police and the goondas. Stay inside your homes till things calm down.

• If you want to buy today, decide if you can take the risk. If you have waited for blood on the street, your time is here. Nobody can predict a market bottom, now is a good time to buy. Those who want to buy, but want less risk, wait for things to stabilise and the new government to announce policy. You may buy at a higher price, but at a lower risk.

• Those in a Systematic Investment Plan (SIP) should absolutely not sell now. In an SIP you spend a certain sum each month, say Rs 3,000, to buy units of a mutual fund. When the markets are high, you buy at a high net asset value (NAV or price per unit of a fund) and fewer units, when markets are down, you get units at a lower NAV and get more of them. The average price, then, works out in your favour over a year. To get out of an SIP today would mean that after having bought when the market was high, when the chance to buy at a lower price has arrived, you have sold! Don’t do it. This is, in fact, a good time to enter an SIP.

• If you have lost your stomach due to the mid-May madness and want out of equity, sell at each spike in the market. Re-assess your risk profile and reduce the asset allocation towards equity, as a down market is a good time to really assess your risk-appetite.

Finally, remember this: a higher return in the stock market will only come with risk as the pillion rider. If this makes you unhappy, stick to the bank FDs and debt funds.