Do not invest in lump sum when market is volatile

The market has slipped below 19000 points. Though this is quite a come down from an interim high of 19701 points that the Sensex had touched in the beginning of April, nonetheless, even the current level would be considered quite healthy as compared to a level of 17400 points that the index had fallen to as recently as on February 10.

For some time now, on account of a combination of spiraling inflation, tightening money supply, rising interest rates and its consequent effect on corporate earnings, stock market analysts have been predicting a correction. Of course, the US economic downturn, the debt crisis in the Eurozone and the Japanese natural and nuclear disasters will not help matters.

Therefore, that a correction or a consolidation will arrive is a certainty. However, when will it happen and to what extent is something no one can predict. Those who tried to have failed miserably. In such a scenario, what should retail investors do? Well, one idea could be to go back to basics.

Actually, to succeed in the stock market, the mantra is simple —- Buy low, Sell high. However, as straightforward as this may sound, it is one of the most difficult strategies to follow. For the simple reason that it goes against basic human instinct.
When the times are good and the indices are flourishing, the first impulse is to try and participate in the party. This is done by buying shares. And the first part of the mantra is flouted. Later on, when the bull run ends and the valuations start sliding, panic sets in and shares are sold in a hurry —- thereby flouting the second part. In the end what happens is that the investor has done just the opposite —- bought high and sold low. This cycle keeps on getting repeated unless one makes a conscious effort to come out of it.

In any case, as of now should you be in cash and out of the market? Or is there some way to go for the bull run and you could still be a buyer? Well, no one knows the accurate answers to these vital questions —- however, there are some basic steps you can take in this scenario. Lets consider these.

Book Profits Partially
It is next to impossible to sell at the peak and buy at the bottom. Therefore, if you are getting a reasonable valuation for your shares and mutual funds, undertake partial profit booking. Looking at it in another way —- you must have invested a portion of your portfolio in equity and the other in fixed income. Say the proportion was 60:40 in favour of equity. At current market price, recalculate the mix. Because equity values have risen over time, chances are that the debt percentage in your portfolio has reduced. However, since 60:40 was your pre-decided risk profile, the best way to restore parity is to sell some equity and move into cash or short-term debt. Indirectly, you have booked partial profits.
While booking profits, keep the tax angle in mind. By now, most investors would know that long-term capital gains from equities and equity funds are exempt. Therefore, take care to see that the investments that you are selling are at least a year old. If you sell any stock or equity MF that you have purchased less than a year back, then you will have to pay short-term capital gains tax @15%.

Never time the market
Trying to time the market has never worked in the past and will not work in the future. This is one lesson that I keep learning continuously. To be honest, sometimes I too succumb to the temptation of trying to get better value for money while investing. For example, at the aforementioned 17400 points, I advised some of my clients to defer investing in the expectation that the valuations will fall further and one would get a better price for one’s investments. Gold had hit a (then) record high of $1,434.65 to an ounce, oil prices were skyrocketing and the unrest in Tunisia and Egypt was rapidly spreading across the Middle East and North Africa. I fully expected the market to react to this unfolding of events. And the market did react - by climbing 2000 plus points over the next two months!! Lesson - never underestimate the wisdom behind Warren Buffet’s words - “Timing the market is impossible, but time in the market is crucial”. Yes, this gem from Buffet is oft quoted but the fact is that it is seldom practiced. Train yourself to practice it as much as possible.

Last but not the least
During times of risk aversion, moving from equity to debt seems a good idea, provided debt instruments are available. Secondly, interest on all debt instruments is fully taxable. Plus the lock-in factor has to be considered. Income funds are not an option since interest are rates rising. What you need is some fixed income instrument that is not taxable, that doesn’t have a significant lock-in and that won’t eat into your capital. The only thing that comes to mind is floating rate funds.
Till the market consolidates, you could temporarily park your money in such floating rate schemes. There is virtually no interest rate risk and the money is fairly liquid. FMPs and Derivative Funds are two other instruments where the interest rate risk is almost eliminated. However, the liquidity is not as good.

To sum
As of now the market is pretty volatile. But this volatility can also be a weapon. Do not invest in a lump sum. Instead stagger your investments by way of an SIP or an STP. Do not try to time the market. Do not invest based on tips or intuition. Take care of asset allocation by investing a part of your money in FDs / PPF and the balance in mutual funds. Choose plain vanilla diversified equity and balanced funds with a track record of at least five years if not more. If you try and employ the abovementioned ideas you just cannot fail.

The writer is Director,
Wonderland Consultants,
a tax and financial planning firm. He may be contacted
at sandeep.shanbhag
@gmail.com