Gain and loss is part of your investing journey. Before reacting to a loss it is important for you to understand why it has been created. Essentially, your portfolio can be ‘in loss’ due to two reasons – you’ve picked bad funds or the market is going through a downturn. In this article, we tell you what to do in each.
1. You’ve picked bad funds
If the loss is due to bad fund selection, identify the bad apples. These will be funds that are falling behind their benchmark and peers over long periods of time. If you do have such funds in your portfolio, do not hesitate to sell them.
However, look at what costs you will incur by exiting these funds. These are typically exit load and capital gains tax. Out of the two, a loss making fund will not incur taxes because only gains are taxed and not losses. If the exit load is also small or inapplicable you can consider switching.
Solution: Rebalance your portfolio in favour of high quality mutual funds
2. The market itself is going through a downturn
In this scenario, there is little you can do but stay put. Spread out your investments through SIPs so that you can take advantage of a falling market. An SIP will give you more units of the fund, when markets fall. Cashing out and realising your paper losses is one of the worst things you can do.
Solutions: Stay put, Spread your investments, Look for strategic entry points, Remember, time is in your favour
- Stay put: Do not realise your losses by exiting in a state of panic.The Nifty 50 dipped from 6000 levels in 2007 to 3000 in 2009, as the world financial crisis hit. Anyone who left the market at that point would have realised a 50% loss. However since that point, the Nifty has tripled since then and now sits at 11,000 levels. A gain of 3 times over in just nine years translates to a CAGR (Compounded Average Growth Rate) of 13% – enough to generate a great deal of wealth. At the end of it, an investor who stayed put would be sitting on a 200% gain.
- Spread your investments: through SIPs or STPs. An SIP invests a fixed amount into a mutual fund every month. An STP transfers a fixed amount from a liquid fund into a mutual fund every month. Both these vehicles are better suited to downtrending markets than lump sum investments. They allow you to get more units of your chosen mutual funds at lower prices.
- Look for strategic entry points: A market dip is also an opportunity. It gives you a chance to increase your holdings of mutual funds and make larger profits when markets rally. If you do not want to do this through SIPs/STPs and have a strong risk appetite – you can make lump sum investments when markets drop. This can be a stressful path if markets keep falling further and you have to be willing to stay invested for at least 5 years to see real results. However the gains from such strategic investments can also be high.
- Remember, time is in your favour: In the long run the direction of the market is up. This is because the market is ultimately driven by real GDP growth and inflation, both of which are positive in the long run.