Why is exiting your mutual fund investments during a crash bad for you?

Mintd Team
June 29, 2022

We all have heard that markets move in cycles – they go up and eventually come down, and vice-versa. When markets go up, it's called the bull phase; when they fall, it's called the bear phase. But the question is, what impacts the market movement? Well, it is almost impossible to predict how markets move. The 4 E's that drive markets up or down are earnings, economy, expectations and emotions.

Every investor has a different perspective on the markets. Let's say I like to invest across market cycles. Irrespective of the current market trend, I diligently invest with a long-term perspective. At the same time, some investors may try to time the markets and make some quick money. This strategy is not for all, and even the best of the best brains have burned their fingers while attempting to time the market.

Currently, the Indian markets are extremely volatile, and the major confusion is whether to add new investments or buy more of what I already hold?

Well, the answer is quite simple. Amidst the market volatility, it's better to hold on to your investments. Don't panic and exit. If your investment horizon is long-term, then sit tight. If your investments are well planned by considering your risk appetite, investment objective and duration, I don't think you should worry about the short-term corrections. Moreover, if you see a fundamentally strong asset and have some spare cash, go for it and invest.

Let’s take an example to understand the implications of exiting the investments during a crash and what happens if you hold on to them.

Divya and Komal invest in the UTI Index fund and Nippon India Small Cap fund, respectively. They started their SIP investments on 1st June 2017 with an investment tenure of 10 years. Following are three possible scenarios for both.

Scenario 1: Stop SIPs and withdraw the investments during the Covid-19 market crash
Graph Source: Value Research
Graph Source: Value Research

With a fear of a market crash, exiting the investments has resulted in negative ROI for both Divya and Komal.

Scenario 2: Stop SIPs and hold on to the corpus
Graph Source: Value Research
Graph Source: Value Research

Despite stopping their SIPs during the market crash in March 2020, Divya and Komal were able to generate positive ROI on their investments as they held on to the corpus. Compared to the above scenario, it is clear that holding on to your investments through volatility will eventually help you generate better returns.

Scenario 3: Continue with SIPs
Graph Source: Value Research
Graph Source: Value Research

If Divya and Komal continue with their SIPs through the market volatility until the end of their investment tenure, they may generate higher returns. Over the investment tenure, you can benefit from rupee cost averaging and the power of compounding - this help in averaging out the investment cost and market volatility.

Thus, even though markets are volatile, you can still benefit from them. We have seen that Divya and Komal have suffered negative returns during the market crash (scenario 1). And at the same time, they enjoyed good returns when they held on to them (scenario 2 & 3).

Therefore, do not rush your decisions, volatility will eventually stabilize, and your investments will get back on track. All you need is a long-term investment horizon with some discipline.

Investing is a Long Term Business.
When done for the long term in a disciplined manner, you can overrule the impact of market volatility and enjoy high returns. We all invest for different goals and have different investment horizons. Ideally, a long-term investment must be for a duration of not less than 5 to 7 years.

Counter Market Volatility with Disciplined Investing.
SIP investing through market volatility will help you accumulate more fund units when the NAV falls. And enjoy higher returns when NAV appreciates. Thus, you can average your costs and enjoy better returns by investing through market ups and downs.

Recently, many investors are of the opinion - I have made good returns since 2020, and markets are going up; why should I worry?

Before answering the question, let's look at some quick facts. Post the pandemic; the retail investor accounts have increased by a record 10.4 million. In the year 2020-21, there were 81 lakh new accounts (or folios in a mutual fund). In FY2022, the mutual fund industry has witnessed over 3 crore new investor accounts.

With large disposable income at hand, Indians were experimenting their hands at investing, and thus, the markets have witnessed record-high participation from the retail segment.

Coming back to the question, when the markets fell in 2020, many investors entered the market at a low and are enjoying high returns today.

But, this is just a one-off case, and it is important to remember that the bull run is also not permanent. The past two years have proved to be extremely profitable for the mid and small-cap stocks and funds. However, the longevity of the profitability is always questionable. Once the markets start to correct, the most affected segment will be the mid and small caps.

Furthermore, looking at just two year returns and thinking it’s easy to make money in the stock market is absolutely wrong.

Continuing with the above example, let’s look at annualized returns for Divya and Komal.

The 3Yr annualized returns of both UTI Nifty Index fund and Nippon India Small Cap fund are negative. This is primarily because of the Covid-19 impact. While looking at short term (1Yr) and long-term (5Yr), the return from the Index fund is more or less stable. While the annualized returns of the small-cap funds have fluctuated quite significantly.

For less volatile and stable returns, investing for the long term is the best strategy. Long-term investing works in favour of all equity investments. However, passive funds are a good option if you are looking for some stability. Index funds often generate returns that are close to market returns.

Lastly, the near-term outlook for India may not be the brightest, but the long-term outlook casts a different light on the situation. Therefore, ride the markets like a pro with a long-term outlook.

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