Here's an infamous quote by Stanford professor Scott Sagan: “Things that have never happened before happen all the time.” It's important for anyone who invests in the financial markets to imbibe this simple truth. Extremely rare events that shake the world and have compounded negative consequences have come to be known as black swan events. Some examples include the World Wars, natural calamities of massive scale, the dot-com bust of 2001, the financial crisis of 2008 and global lockdowns.
Hence, you must invest with the mindset that a black swan event can shake up the world, and your portfolio will pay dividends in the long term.
Three Mistakes to Avoid
Following are three major mistakes investors must avoid during black swans.
- • Some investors panic and pause/ stop their mutual fund SIPs (Systematic Investment Plans). This is a costly mistake, as downturns always allow investors to purchase units at a lower price, thus averaging the cost of the most expensive units purchased during a bull run. If you stay invested in your SIPs, you will reap the benefits over a three to five-year horizon.
• Many investors rush to liquidate their mutual fund investments during black swans, often at massive losses. The compounding effect of the asset class is completely lost, and one emerges with a much lower net worth. Once the market bounces back - it may take a few weeks, months, or years - one must start investing from scratch. When markets start performing well, investors rush to purchase assets at a higher price, and the cycle continues. To break the cycle, one must exhibit very different behaviour. Hence, blanket liquidation is not a wise move. Stay invested, and the value of your assets will grow once again.
• Uncertainty keeps many investors away from investing altogether. Rather, this is the time for investors to purchase equity-based mutual funds such as the Quantum Long-Term Equity Value Fund and the Quantum Equity Fund of Funds, which invests in 5-10 diversified equity schemes of third-party mutual funds shortlisted after in-depth and thorough research. One can also consider tax-saving under section 80/C by investing in Equity-Linked Savings Schemes (ELSS), such as the Quantum Tax Saving Fund, offering multiple benefits such as higher returns and tax deductions under Sec 80C of the Income Tax Act, with a mere three-year lock-in period. There is also a rising interest in ESG funds such as the Quantum India ESG Equity Fund.
Build the Right Mindset
The aim of this conversation is not to alarm investors but to equip them with the right tools and foresight to invest wisely. Often, standardised forecasting tools and investment models cannot predict the occurrence of a black swan. However, awareness of its potential will empower investors to build portfolios that prepare for such eventualities. Retail investors must ideally be prepared to encounter black swan events at least once in their lifetime.
The second aspect to consider is that markets usually bounce back after black swan events, unless a fraudulent business completely implodes, turning the stock price to a pulp. A mix of caution and steadfastness can help one weather the emotional and financial storms triggered by black swan events.
Diversify Early on
Over the last few months, the markets have displayed a volatile trajectory even before the onset of the Ukraine-Russia conflict. We have seen overstretched valuations, which have quickly plummeted with the onset of newer crises. There could be multiple reasons for the same. However, a basic principle that has stood the test of time for investors is to build a diversified portfolio early on. Seasoned and savvy investors are always mentally and financially prepared for market volatility and follow the rule - don't put all the eggs in one basket. Here's a list of broad asset classes to consider when building the foundation of your portfolio:
- • The first step one must take is to stash 12 months of living expenses in an emergency fund. An emergency fund is a cushion during unprecedented times. The funds can be invested in a debt mutual fund, comparatively one of the least volatile asset classes, offering quick liquidity during crises.
- • The second step is to invest in equity, an asset class that has the potential to accelerate one's wealth creation journey. However, most investors are not savvy about picking individual stocks. A safer approach is to invest in equity-based mutual funds; dedicated mutual fund managers who strategically invest in the stock market aim to optimise on market opportunities. There's a popular misconception that mid-cap and small-cap companies cannot withstand volatile markets. This is not necessarily true. It's more important to look at balance sheets and ensure that they are profitable businesses. Some equity mutual funds also come with additional tax-saving benefits. If you stay invested for at least a year, you also stand to gain from long-term capital gains.
• The third step is to look at gold. While traditionally one invests in physical gold, today, investors have the option of investing in gold mutual funds, which offer a seamless investing and redemption experience. Low volatility and quicker liquidation, as opposed to physical gold, are some additional perks. Many grapple with this question: Should I buy gold even when prices have escalated? There is no blanket response - it depends on your investment strategy. However, research indicates that investors who invest consistently every month instead of timing the market end up with a larger net worth over their lifetime.
Click to know more about the 12-20-80 Asset Allocation Strategy.
Cultivate the Right Investor Behaviour
Black swan events have the potential to trigger market volatility. Stock prices may plummet, sending investors into panic mode. During these times, millions of investors sell their mutual fund units in a hurry. In turn, they incur significant losses.
Simultaneously, as gold prices go up, investors display another type of erratic behaviour; they may rush to buy gold. But the big question is - is this the right time to buy gold? Investors must adopt a mindset of perseverance during these times and not react in haste. Decisions must be based on rational thinking and not emotions.
The Takeaway
Taking steps to diversify early on, and being mindful of your behaviour during a black swan, can help sufficiently shockproof your portfolio during unprecedented downturns. With each event, you get savvier about staying resilient in such times, both emotionally and financially.
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