Timing the market & investor psyche

With the mayhem unleashed due to the downgrade of US to AA+, markets across the world have experienced correction. In times like these, logical thinking is the first casualty. There are market observers who suggest that there is more pain and the market can trend down. There are those voices which are harping on the popular sound-bite that “Cash is King”. There are other more optimistic ones who suggest that markets have been anticipating this and are already factored into the fall. By implication, what they mean is that the downside is limited and the upside potential is higher.

Now such divergent voices are what cause confusion for the normal investor. As it is, they are scared as the markets are falling. Do they invest now, hold on to what they have or cash out?

Timing the markets has always been a subject of much debate. Paradoxically, retail investors tend to think that they can time the market well, based on what they read and hear. That is surprising as timing the market is virtually impossible, even for the most savvy investors, which includes fund managers.

Ironically, that is the advice investors want today from their advisors. So, what can the investor do…

First, they need not change their allocations now to accommodate the new kid on the block which is firing on all cylinders – Gold. Most people have long-term goals and meeting them would require a consistent strategy. One should not look at changing the strategy overnight, whenever there is some change in the environment. The strategy would have to be revisited only if the events have considerably changed the risk-return possibilities over the period, which calls for such a change. This is not one such event.

Indian stock markets have been considerably driven by FII money and when money moves back to western shores seeking “safe havens”, the markets fall. But, if one looks at the indebtedness of the various countries and the prognosis for their economies from here on, FII money will sooner than later come back to emerging economies with potential. India is one such economy, which has the potential to grow at 7%+ levels. Hence, it is a fact that though there are short-term problems, the medium to long-term outlook is good.

Hence, apart from changing some tactical allocation & tweaking the portfolio a bit, one should let the strategy remain intact. This means continuing SIPs/RDs which are going on, continuing with the investments done in the past to achieve long-term goals and not attempting a major change of the allocation just because Gold seems to be the star on the horizon. Gold continues to be a good hedge against inflation and due to it’s negative correlation with equities, it also reduces risk in the portfolio. The way Gold has run up does not bode well for this commodity and correction can happen in this, in times ahead. There seems to be a bubble building up in Gold but people don’t seem to be recognizing that. There are those who are going whole hog into Gold after liquidating investments from other assets, which is not a good strategy at all.

Since the markets are in correction mode, it may be a good time to invest in Equity and Equity oriented Mutual Fund schemes, for those with a long-term view. Such investors should split their investments and invest in small lots, over time. This will enable them to invest at low market levels and take care of volatility.
Investor psyche comes in the way here… there are those who want to shift their money away from equities and into FDs and other such debt instruments. That again is not a good strategy. Investing in equity at this point would give the best bang for the buck. Whether investors see it that way is another issue. Currently they are running scared – much against their best interests.

Authored by Suresh Sadagopan ; Article published in Moneycontrol.com on 18/8/2011