What should you do when the stock markets are at high level

The year 2020 was one of the most volatile years for capital market in recent years. With outbreak of COVID-19 pandemic threatening to overwhelm healthcare infrastructure, the stock market saw one of its worst crashes in the month, with the Nifty falling more than 20%. The ensuing lock-down resulted in one of the worst economic contractions we have seen in several decades. Then as the economy was gradually re-opened, the stock market recovered and rallied on to an all-time high in the last quarter of calendar year 2020. While bull markets are always more welcome in bear markets, it has been seen that investors often make some mistakes in bull markets which harm their financial interests in the long term.

In this article, we will discuss what investors should do in bull markets.

You may also like to read how to be prepared for uncertain times.

Avoid temptation of booking profits

If you invested in Nifty 1 year back (as on 29^th January 2021), then you would be sitting on 14% profit. Your profits in midcaps or small caps can be even higher. Some investors may feel the temptation to book profits at these levels. However, you should resist this temptation because the opportunity loss for you can be significant. Equity as an asset class has the potential of giving superior returns in the long term due to the power of compounding.

You should have an investment plan and remain disciplined.

Have a diversified portfolio

In a bull market, certain stocks or funds can give very high returns. You should avoid investing large sums of money in such stocks or funds. Diversification is an investor’s best friend in any market condition – bull market or bear market. Diversified equity mutual funds which invest in sufficiently large number of stocks across industry sectors are good investments for retail investors in bull markets. Even among diversified equity funds, you should ensure that you invest in the right mix of large caps, midcaps, small caps, large and midcaps, multi-caps, etc. according to your risk appetite.

You should consult with your financial advisor if required.

Here we suggested reading this article - how to choose the right mutual funds according to your need.

Asset allocation is important

Asset allocation is required to diversify risks and ensure that you achieve your financial goals. Every investor should have a target asset allocation (i.e. percentage equity and debt in your portfolio), which you should strive to maintain irrespective of market conditions. In a bull market, your asset allocation may go awry because the equity portion of your portfolio will grow faster than the debt portion. You should review your portfolio on a regular basis and make appropriate investments in debt funds to rebalance your portfolio’s asset allocation and bring it back to your target.

Get rid of under-performing investments

Many investors hang on to under-performing stocks or funds for very long periods of times, either because they do not review their portfolio regularly or for the fear of making a loss. Whatever the reason for not selling, hanging on to under-performing stocks or funds can harm your financial interest in the long term. What is an under-performing fund? Every mutual fund scheme has a benchmark index. If your equity mutual fund scheme is under-performing versus its benchmark index for long period of time (at least 3 years or longer), then you can consider redeeming it and switching to a scheme whose performance is better.

You should try identifying which schemes in your portfolio are underperforming and which schemes you should remain invested in.

Invest through SIPs

Early stages of bull market rallies are often fuelled by high liquidity in the financial system - this rally is no different. The US Federal Reserve is buying bonds to provide liquidity in the financial system in wake of economic slowdown caused by COVID-19. This is in turn has weakened / is weakening the US Dollar, which has resulted in the FII money flowing to emerging markets like India. In a liquidity fuelled rally, valuations can get stretched a lot. If you make large investments at very high valuations risk is higher and you may get lower than expected returns. Investing through SIPs over a sufficiently long investment period can be a good option because you can invest at different prices and benefit from Rupee Cost Averaging.

The chart below shows the growth in value of Rs 10,000 monthly SIP in Nifty 50 TRI from 1^st January 2000.

As you can see from the chart below, you can create considerable wealth by investing through SIPs in both bull and bear markets.

Source: National Stock Exchange (Period 01.01.2000 to 01.01.2021), Advisorkhoj Research. Disclaimer: Past performance may or may not be sustained in the future.

Suggested reading: How can you maximize your mutual fund SIP returns

Invest according to your financial plan

Your financial plan is your friend, philosopher and guide across all market conditions. Investing according to your plan, for your different financial goals (short term, medium term and long term) and your risk appetite will keep you away from making impulsive (based on greed and fear) or ill-informed investment decisions. Investing according to your financial plan includes doing the basics of investing right i.e. knowing how much to invest for your goals, where to invest, proper asset allocation and re-balancing, investing systematically for your long term goals and remaining disciplined in your plan, irrespective of market conditions.

If you do not have a financial plan, then we recommend that you develop one working with an experienced financial advisor who understands your needs. A financial plan need not be cast in stone. You should review your financial plan from time to time and make necessary changes to it, depending on your financial situation e.g., income, expenses, assets, liabilities, etc.

A financial plan by itself will be a guiding light in navigating your way through the volatility of financial markets.

Conclusion

Bull markets signify optimism among investors. Positive investor sentiments are justified in the sense that, the worst of the economic crisis caused by COVID-19 is behind us and we can see clear signs of economic recovery. However, the path to full recovery will be long and also bumpy.

Equity investors must be prepared for volatility – discipline and patience are of utmost importance in investments. Markets can move up or down, but your financial goals remain the same. You should always invest according to your financial plan and consult with your financial advisor if you need any help.