Last Updated on Apr 26, 2022 by Aradhana Gotur
Strategies to deal with market volatility range from very complex hedging to very simply doing nothing. While long term markets trend up, the path, especially in the short term, can be extremely violent.
In fact, most Mutual Fund (MF) investors make lower returns than the MF track record because they enter and exit at the wrong points. Most of why this happens is that they are unable to deal with volatility.
It is also important to remember that market volatility is inevitable. Volatility is a measure of risk, and therefore there is a risk/ reward curve on which different assets sit. Crypto is very volatile, and “expected returns” from it are very high. Your savings account is not volatile, and therefore your returns from it are low.
When you invest in an asset, understand how much it swings and sign up only if it fits your goals.
Let’s look at a few ways to tackle volatility.
Table of Contents
Asset allocation
You must have a holistic approach to your portfolio. If you have Rs. 100, invest it across different asset classes that have varied risk/return profiles. If you do this right, your portfolio as a whole will not be very volatile. A case in point is the day Putin invaded Ukraine – if you held some gold in the portfolio along with equities, your portfolio would be far less volatile than someone who say owns mostly small-caps. That’s because gold goes up when there is macro uncertainty. The flip to this is to remember that even on the upside, no one asset class will have a dramatic impact on performance. Therefore, in a bull market, your returns will be lower than a pure equity portfolio.
However, the point of asset allocation is to get to your target return to meet goals and avoid as much risk/ volatility as you can in the process. Therefore, it removes any FOMO (fear of missing out) and JOMO (joy of missing out) from investing.
We have a smallcase called Upside Shockproof that we started specifically to give investors a more holistic portfolio.
Hedging
Buying a simple put on the NIFTY is a great way to protect your downside. When you buy a put at, say, NIFTY level of 15,000, you are buying an option to “sell” at that level. So, if the NIFTY drops to say 14,000, you can sell it to the buyer at 15,000 and buy it from the open market at 14,000. Buying this option costs money that you pay upfront, and if the NIFTY never falls below 15,000, your option is worthless. Therefore, you pay the option cost to protect your downside.
I have given you a very simple version of how a put works. In reality, people use complex strategies in the futures and options (F&O) market.
From your perspective, if you want to just protect your equity downside, a NIFTY put is a very liquid instrument that allows you to do just that. You must remember that buying this option costs money and comes out from any gains you make on the upside.
Invest more opportunistically, also known as “Buy the dip”
Turn the volatility into an advantage by buying more of an asset that you believe in. “Buy the dip” is a great strategy for investing more in an index, product or stock that you have strong conviction around.
If volatility doesn’t make you jittery, use a correction to your advantage and average your cost down.
Do nothing
If you are comfortable with your investments, this is the correct strategy to tackle volatility. The more you zoom into a market – every week, every day, every minute is more and more volatile. The more you zoom out, the return curve looks smoother.
On average, all of the year’s equity returns are made in 15-20 trading days. It is impossible to know what those days are and time the market. Hence, investors who want to make equity returns must contend with equity volatility.
In conclusion, I must give very boring advice – ignore the noise, news cycles, have a long term approach to investing and relook at your asset allocation periodically is the only way to systematic wealth creation.
