How to handle the ups & downs of equity markets?

A rider in giant wheel feels more frightened when he is at the top. Similarly as we climb the hill the fear of falling from it increases. Exactly same way when stock market rises we should be feel more nervous. Interestingly speculators follow exactly the reverse behavior. When equity markets are high they feel safe and when they fall they feel nervous. In reality equity markets are less risky at 15000 levels than at 21000 levels.

However all speculators find equity markets risky at 15000 and not at 21000. Putting it differently, under normal circumstances all of us always prefer to buy any goods and services at lowest possible price. In case of equity investing speculators always prefer to buy at higher prices.

There are two reasons for this behavior. Firstly there is what is called as anchor effect. We tend to link our decision to previously demonstrated number. Suppose if market has moved from 10000 to 21000 to 15000. Firstly at 21000 levels we would have 10000 levels in mind and hence we will feel euphoric. At 15000 levels we would have 21000 levels in mind and hence we would feel dejected. At 15000 levels we forget about 10000 levels.

Having anchoring effect is like driving the car only by seeing into rear view mirror. If we keep driving the car by only seeing in rear view then we will surely bang the car. To move ahead, we must see in front. Rear view mirror only acts as guiding post.

Secondly most of us invest in any class of assets without aligning those investments to our goals. Our behavior is like of a passenger who sits in a train without knowing where he wants to get down. While this may sound absurd, the fact is speculators always behave in absurd manner. If we sit in a train without knowing the station we want to get down then at every station we will feel restless. Same thing happens to a speculator who has deployed funds in equity market without aligning it to his financial goal. A speculator will always feel restless. At every piece point he would want to know whether he should sell, buy or hold.

On the other hand an investor, who has aligned his investments to his financial goals, does not feel restless at every price point. A train passenger who is sure of his station will not feel restless even though at every station there will be passengers who will alight and board the train. He knows his station and hence the moment train reaches that station he will alight the train. Similarly an investor knows the financial goals for which he is investing his funds. The moment he nears the goal he will liquidate his investment.

Suppose if we are saving for a financial goal, which is eight years away, then eight bad months should not bother us. However if we have not aligned our investments to our goals then we will panic even if equity markets fall for eight weeks. Usually investing in equity markets is recommended for a financial goal, which is more than 7/9 years away.

Lastly remember, we make investments so that we get peace of mind. If our investments make us feel worried and restless then rest assure we have not properly aligned our investment to our financial goals.

- Gaurav Mashruwala

The author is a Certified Financial Planner. He may be reached at gmashruwala@gmail.com

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