As markets fall, what investors should keep in mind when buying on dips

A principal thought which guides most investments is: to buy an asset at a low price and sell at a high price. This holds true even for risky assets which are exposed to high volatility. Equities are not a completely different beast.

Investing is not a linear journey. Markets sometimes fall or even plummet and portfolios turn red. Investors finds it difficult to arrest the fall in value of their portfolios. Thereafter, investors have to analyse their portfolio and identify weak links. In fact, it is how investors deal with volatility that determines how much they can gain in the long-term.

One expensive mistake most investors commit is that they are not prompt enough to sense the attractiveness of a stock. They wait for much longer periods than necessary when it comes to buying shares of a company which is attractively valued. They forget that the perfect price for a stock is part of a theoretical analysis and not a practical decision-making process. Waiting for much longer periods than necessary reduces the scope of generating excess returns or alpha. Besides, when markets fall, investors do not realize that panic overtakes sound logic and patience. In this context, most investors miss out on a key investment lesson: buying shares on dip.

Evaluate price fall

A fall in the price of an asset is a good time to return to the drawing board and assess whether the rationale on which the initial investment was made is still relevant. Investors need to ascertain what factors caused the underperformance of the stock/portfolio.

Averaging is advised only when they are convinced that the long-term story of the stock/sector is still intact. Buying on dips requires a disciplined approach; it can pay off in the long-term. However, on assessing the underperformance of the stock/portfolio, if investors find the risk-return profile has undergone a change, they need to take tough decisions like exiting the stock.

Stay diversified

While we talk about averaging and rebalancing our portfolio during volatile phases in the market, one sound investing principle which always gets tested is diversification.

Diversification reduces unsystematic risk of the portfolio and lessens concentration risk. A well-diversified portfolio delivers better risk-adjusted returns in the long term in comparison with portfolios which invest in one asset class or a bunch of securities. A macro strategist may want to ascertain the asset allocation depending on the relative attractiveness of each asset class. However, average investors may not have a world-view of various asset classes. In such a situation, it is beneficial for investors to link asset allocation to their financial goals. If investors are saving for a long-term financial goal such as retirement that is, say, due in 30 years from now, they can allocate more to risky asset classes such as equities and less to bonds. A person who is saving for a financial goal such as a down payment for a car to be done in a couple of years from now should ideally stick to investments in bonds.

As investors keep investing in line with their asset allocation, there is a fair chance that they will achieve the investment goals. And as these investors move closer to their goals, they should shift investments to relatively less risky assets.

Keep rebalancing

Buying on dips is to be considered only after investors review their portfolio. Investors can compare their existing portfolio’s asset allocation with the original asset allocation that they started with. If there are deviations, they can then take corrective action. For example, if an investor started with a 60% equity, 30% debt and 10% gold asset allocation and now sees the asset allocation at 50% equity, 38% debt and 12% gold, then it makes sense to sell debt and gold to an extent and buy equities in such a manner that the original asset allocation remains intact.

In addition to time-bound rebalancing, savvy investors can rebalance their asset allocation if asset classes move by a stipulated percentage, say 15% of their original allocation. For instance, going by the above example, if equity moves above 69% or goes below 51% even before completing a year from the previous reset, then it calls for a review of the asset allocation. Investors can set the range for allocation to each asset class in their portfolio and then rebalance.

Abhishek Goenka is founder and CEO, IFA Global

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