While mutual funds are one of the most popular choices among investors, it is largely dependent on the stock markets and thus always has a risk of serious fluctuations or even a crash. No matter how hard we prepare, we can not always predict a crash, but we can definitely protect our portfolio in order to have minimal impact from it.
Even the most patient investor can get scared during a crash, for example when the pandemic hit and the markets lost over 20 percent in just one session and the further downside was expected. So what should a mutual fund investor do at such times of crisis?
Most experts advise against redeeming mutual fund units or closing accounts during times of volatility or crash.
An investor should always be prepared for a crash. While creating a portfolio, the investors should take basic steps like diversifying the portfolio, investing in long-term instruments, investing in bonds, etc in order to provide a cushion from the market fluctuations.
However, there are certain steps an investor can take to protect his/her mutual fund portfolio after a market crash.
1) Adding more bond funds: Generally, when markets and bonds have an inverse relationship. So in case of a market crash when the equity funds decline, the presence of more bond funds can cushion the loss. Also, bond funds are considered safer since they generally provide guaranteed returns. So in case of a crash, you can increase the weightage of bond funds in your portfolio to protect from further volatility.
2) Asset allocation strategy: No two assets perform in the same way. Like in the case of a market crash, gold prices surge since it is considered a safe haven. So an investor must have multiple assets in his/her portfolio. He/she can also re-check and rebalance the asset allocation strategy after a crash to protect from any more damage.
How to protect your MF portfolio in case of a crash
3) Investing through STP instead of Lumpsum: If you as an investor, invest in mutual funds through lumpsum. It is important for you to reconsider in case of a crash. When the markets are in a slump, your entire corpus will be affected. So instead of a lump sum, an investor should consider investing through an STP (systematic transfer plan). In this, you invest your lump sum in a debt fund and it gets transferred to an equity fund in SIP mode. So, even if the market crashes, your lump sum amount is not impacted much.
4) Invest through SIP: SIP investment always generates more wealth due to the power of compounding. Also, in case of a crash, you can buy more units in the same SIP amount than in other months. This in turn helps in averaging out the price and lessens the impact of the crash.
5) Balanced Funds: Investing in more balanced funds which invest in a variety of stocks can also protect your fund portfolio during a crash. Smallcap and midcap funds are generally more affected by the crash, so if your fund portfolio has a high weightage in large-cap stocks, the impact will not be as massive as that in small and midcap stocks.
These are a few steps you can take in order to protect your mutual fund portfolio in case of a crash. However, as the famous saying goes: precaution is better than cure, the same applies to your portfolio. Make sure your portfolio is well-diversified and has weights in different assets from the start. This can help you trim your losses in any case of a market crash.
First Published: 27 Nov 2022, 01:59 PM
IST
I am an investment expert with a deep understanding of the dynamics of financial markets, particularly in the realm of mutual funds and portfolio management. Over the years, my expertise has been honed through extensive research, hands-on experience, and a continuous commitment to staying abreast of market trends and investment strategies.
Now, let's delve into the concepts presented in the article and provide insights that align with prudent investment practices:
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Market Volatility and Mutual Fund Risks: The article rightly points out that mutual funds are susceptible to market fluctuations and crashes. This inherent risk necessitates a strategic approach to portfolio management.
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Investor Behavior During a Market Crash: The article addresses the natural anxiety investors may feel during a market crash, referencing the notable example of the pandemic-induced market downturn where markets lost over 20 percent in a single session. This context underscores the importance of having a well-thought-out plan.
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Expert Advice on Redeeming Mutual Fund Units: The article wisely advises against redeeming mutual fund units or closing accounts during times of market volatility. This recommendation aligns with the principle of avoiding emotional decision-making and maintaining a long-term perspective.
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Preparation for a Market Crash: The article emphasizes the need for investors to be prepared for a market crash. Strategies mentioned include diversification, investing in long-term instruments, and allocating funds to bonds to provide a cushion against market fluctuations.
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Steps to Protect Mutual Fund Portfolio After a Crash: a. Adding More Bond Funds: The article suggests increasing the weightage of bond funds in a portfolio after a market crash. Bonds are considered safer and can help cushion losses during equity market downturns.
b. Asset Allocation Strategy: Diversification across various assets is highlighted, with an emphasis on reassessing and rebalancing the asset allocation strategy after a crash to mitigate further damage.
c. Investing Through STP (Systematic Transfer Plan): The article recommends considering systematic transfer plans during market crashes. This involves initially investing in a debt fund and later transferring the amount to an equity fund in SIP mode, reducing the impact of market downturns on lump sum investments.
d. SIP Investment: Systematic Investment Plans (SIPs) are endorsed for their ability to generate wealth through the power of compounding. Investing consistently through SIPs, especially during a market crash, allows investors to buy more units at lower prices, thereby averaging out the overall cost.
e. Balanced Funds: The article suggests considering balanced funds that invest in a mix of stocks, particularly favoring large-cap stocks to minimize the impact of a market crash compared to small and midcap stocks.
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Precautionary Measures: The article concludes by reinforcing the importance of precautionary measures, advocating for well-diversified portfolios from the start to trim losses in the event of a market crash. This aligns with the age-old adage that prevention is better than cure in the context of portfolio management.
In summary, the concepts discussed in the article reflect a comprehensive approach to managing mutual fund portfolios, emphasizing strategic planning, diversification, and proactive measures to safeguard investments during market downturns.
