Corrections are nothing more than a moderate decline in the value of a stock index or the price of an individual stock.
By P Saravanan and Sumit Banerjee
During market corrections, mutual fund investors wonder whether to continue their SIP or sell. However, investors should take advantage of the bull market and also benefit from the bear market. Let’s see what equity mutual fund holders can do during a market correction.
What is a correction and why does it occur?
Corrections are nothing more than a moderate decline in the value of a stock index or the price of an individual stock. A correction usually means a 10-20% decline in value from the recent high. Corrections can occur in any financial asset, including stock indices, the commodity market, or even the shares of your favorite company. When the stock market rises continuously over an extended period, there comes a time when, due to the imbalance between supply and demand, a correction occurs. The market is always reacting to new information and a correction is an indication of a potential reset.
When markets correct quickly, opportunities arise outside of traditional investment channels. For example, investors with a higher risk appetite could probably consider investing in thematic/sector funds which may be more attractive post-slump. Typically, small-cap mutual funds become very volatile in bullish and bearish scenarios, while large-cap funds experience less volatility. Therefore, you can increase or decrease your exposure accordingly. Once the market resets, as a mutual fund investor you can increase your exposure to small cap funds and decrease it to large cap funds and reap maximum benefits when the market rebounds.
Save money to buy in dips
One of the essentials of the science of investing is that you need to have enough cash to invest during market declines without touching the existing investment amount. When prices fall, equity mutual fund investors can take advantage of the situation by investing more each month to buy at lower prices, because prices always eventually go up, so avoid withdrawing money when the prices go down. You can also consider cyclical sectors because during the volatility phase some of them can be hit hard and lower prices can provide a good long-term investment opportunity.
Build a portfolio based on your risk tolerance
Build a mutual fund portfolio with an appropriate asset allocation that matches your investment goals and risk tolerance, so you can avoid emotional investment decisions during a correction. New investors can probably figure out what their risk tolerance is during corrections. If a market correction makes you think you need to be more cautious, wait until the market recovers before making any changes to your existing stock mutual fund portfolio.
To conclude, the correction of the financial markets is inevitable and generally the correction is a short-term movement ranging from a few weeks to a few months. Once the economic shock or geopolitical development causing a correction has come to an end, markets and stocks generally recover and continue to rise.
- Lower prices can provide a good long-term investment opportunity.
- Keep enough cash on hand to invest during market downturns.
- Investors with a higher risk appetite can opt for thematic/sector funds.
P Saravanan is a professor of finance and S Banerjee is a PhD candidate at the Indian Institute of Management, Tiruchirappalli.