Here’s what you should do to get maximum returns when the market crashes.
Stock market crashes have always been big news. It is flashed across TV channels and news websites. Most of the time you hear news readers talking about how Mutual Fund companies purchased shares in the market and that helped stabilise market losses. When such firms buy stocks, should you also follow them whenever there is a market crash? Should you be investing in those Mutual Funds that are buying stocks at lower prices? Not exactly!
Additional Reading: Your First Steps To Investing In The Stock Market
What happens when there is a crash?
When there is a market crash and stock prices fall, note that the Net Asset Values (NAV) or prices of the Mutual Funds also fall. Typically, investors either panic as their returns take a huge hit or they decide to buy Mutual Funds since the NAVs become attractive. Why? The prices of stocks held by the Mutual Fund fall. So, the NAV of the fund will also fall.
What’s the consequence? When you buy Mutual Funds, you get more Mutual Fund units when NAVs fall. How? Suppose the NAV was Rs. 10 per unit when you wanted to invest Rs. 10,000. You could get 1,000 units of the Mutual Fund. Suppose the markets crash and the NAV is now Rs. 8. At this price, you can get 1250 units, that’s 250 more units than what you would have got before the market crash.
How to find out if you should buy?
Getting more units of the fund seems attractive but is that NAV good enough? Is the Mutual Fund actually undervalued? You need to do some calculations here.
Scenario #1 Putting more money in a new fund
You mainly look at the past performance of the Mutual Fund and compare the fund to its peers before zeroing in on a Mutual Fund. Look to see if the expense ratio is low and that there are no exit loads. But note that during market crashes, most funds look attractive and it is difficult to judge whether a Mutual Fund is good enough to invest in.
Also, if the fund you have chosen hasn’t fallen as much as its peers, you might think it is not so attractive. In fact, it might be a better fund than its peers because it has resisted a market crash. So, you need to be very careful when you choose funds during market crashes.
Scenario #2 Putting more money in a chosen fund
Assume you have already chosen and invested in all the funds that you want to. The question is, should you invest more in one of those funds? First, select the fund that you want to put that money into during a stock market crash. Now, look at the history of its NAV. What has the average NAV of the fund been? Is the current NAV anywhere close to the average? If the NAV of the fund is below its 3-year average, you could say that it is undervalued. But you also need to check whether this fall has happened only because of the crash or has it been a consistent fall. If the NAV was sliding much before the crash, you can choose not to invest in that fund. You must make sure that you are, indeed, investing in a fund that is a performer but has slipped due to the overall market.
What should you do?
There are two ways to invest in Mutual Funds. One is investing a lump sum when the market has fallen and the other is through a Systematic Investment Plan aka SIP.
What happens when you invest a lump sum? Let us assume the markets have crashed quite a bit and that you invest a lump sum in a Mutual Fund when the NAV is down to Rs. 50 from Rs. 60. If there is a bull run subsequently and the NAV of the Mutual Fund goes up, you feel you have made a wise investment. But suppose the markets continue to crash? Your NAV will take a plunge along with your dreams of a fat return.
This is where an SIP will help you. If you invest in Mutual Funds through an SIP, you are choosing to invest irrespective of the market conditions. So, you needn’t worry if your NAV slides or rises. Over the long-term the volatility in the NAV will average out, giving you great returns.
Additional Reading: Understanding ‘Systematic Investment Plan’ (SIP)!
How to invest
Remember that no one can time the market. So, there is no ‘right time’ to invest in Mutual Funds. They are diversified investments and will provide you with decent returns in the long-run. If you still want to invest during a market crash, what strategy should you put in place?
The good method would be to combine the following two strategies: Invest a lump sum on the day the markets have crashed, and continue to invest a little more each month. You can choose to step up your SIP when there is a market crash or a period where the market seems to be falling. However, note that this beats the whole purpose of starting an SIP, which is to remain unperturbed during market crashes. Also, if you are planning to stay invested in Mutual Funds for only a short period (this would be any period that is less than 3 years), an SIP just wouldn’t make sense. This is especially true if you are investing in Debt Mutual Funds.
Note that when investing a lump sum, do not put in all your surplus.
Additional Reading: 10 Benefits Of Investing In Mutual Funds
And of course, you should know that these strategies are good only when you have chosen the best funds! Need help? We’ve got you covered.