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How to Avoid Losses In a Volatile Market?
May 15, 2009

Many investors might be pondering if they should be investing or staying on the sidelines this year. What then, would be the best strategy? Find out more.

Author : iFAST Research Team

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The US economy continues to weaken with major bailouts, trillion dollar cash infusions and considering the Indian general elections just around the corner, many investors might be rather worried on whether they should be investing or staying on the sidelines.

What should investors do for this year? A very alluring idea would be to hold cash - redeem your holdings and wait for the dust to settle before going back in again. However, we would urge investors not to adopt extreme strategies in their investing - selling off everything to hold cash in the face of bad news has always seemed to us too extreme a measure to take.

There are a few issues to consider, although it would initially seem to be prudent to adopt the strategy of only holding cash under extremely volatile conditions. The first issue is the opportunity cost of holding cash. Interest rates are extremely low right now (interest rates offered by the banks on savings accounts are 3.5% per annum). If the same amount of money could have been invested into other asset classes which may have yielded a higher return, then the opportunity cost of holding only cash would be very high.

The second issue lies with inflation. Some may argue that keeping everything in a savings account might yield at least a small positive return versus the possibility of losing money if you had invested it and markets fell. However, even for cash, your real rate of return might turn out to be negative in the end. The chief culprit is inflation - a general uptrend in prices. Inflation has been rising in India and the average weekly inflation in 2008 was 9.11%. Taking inflation into account, the overall purchasing power of your money is going to be reduced.

The final reason that many investors will bring up would be that they simply wish to wait out any volatility in the markets now, and that they will re-enter the market and invest again once the "coast is clear". In theory, this represents the best of both worlds, where investors can avoid losses and reap returns when the market rises at the right time. The key problem is identifying "the right time". It is notoriously difficult to get this kind of short-term market timing correct. More often than not, by the time the "coast is clear" to investors, markets would have already rebounded significantly and hence, a lot of the gains would have been missed.

Let's take a volatile year for the Indian market as an example. The most recent one was 2006. Within a single month, the index just lost 30% on account of the fall in the commodity prices, the slowdown in the global economy, a hike in the US interest rates and local SEBI regulation to treat FIIs as traders and not as investors. However, 2006 was a great year - the BSE Sensitive Index (SENSEX) rose 47%. So, if as an investor you ignored the short-term volatility and stayed invested in the Indian market throughout the whole year through the correction, you would have gained a return of 47% for the year, which is pretty good by most investor's standards. Furthermore, the strongest rebound often comes after the worst has happened. Investors who stayed invested throughout 2006 & 2007 have come out on top better than trying to time the exit and entry too closely.

In conclusion, statistically better returns could be achieved through staying invested with a longer holding period, instead of only holding cash and trying to time the market too closely. Just make sure you stay well-diversified across the sectors and asset classes and you should be able to weather any situations, be it high oil prices or a US recession. Also, the fundamentals of the Indian markets remain strong, and we do not expect a US recession to derail the Indian economy, though it will cause volatility. Thus, we believe that facing the year 2009 with a diversified portfolio and staying invested for the long-term, will be the best strategy to adopt going forward.

iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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