Three mistakes in a market correction

'Buy when there is blood on Street'. 'Don't catch a falling knife'.

When the stock market goes into a free fall as it did on Monday, we receive conflicting advice on what to do with our investments. Often, one can spend so much time weighing the pros and cons that the opportunity slips by, leaving us paralysed in inaction.

The one thing investors must not do when the markets fall, obviously, is to panic and sell equities or stop their systematic investment plans. But there are other, less basic investing mistakes that many of us are prone to. Knowing what they are can probably help us avoid them.

Waiting for the bottom

When something we have long wanted to buy gets cheaper, we would usually rush to buy it. But not when it comes to the equity market. When stock prices give way sharply, our conviction in equity investing, inexplicably take a knock.

After the correction, the equity funds that we had already identified for investment a few days ago are now available at a cheaper NAV. But instead of acting, many investors today feel that they should wait for the correction to 'play out' before acting. The problem with this approach is that a) you will know that the correction is over, only with the benefit of hindsight and b) if the decline doesn't continue you will not have taken any action to invest.

What if the NAV falls some more after I buy it? Yes, it can. Yes, the current corrective phase appears to be triggered by real worries about global growth, and it can last a while. But if you were willing to buy equity funds when they were 8-10 per cent more expensive, nothing should stop you from buying them today.

Putting one's investment plans on hold, in the hope that one can jump in when the market bottoms is quite unrealistic. It would be much better to initiate some buying, even if it is with only a part of one's surplus.

Remember that an investor who bought equity funds at a Sensex level of 13,000 in June 2008 didn't time his purchase perfectly. In hindsight, the absolutely best time to buy was at 7,600 levels in October 2008. But the investor who acted in June is still vastly better off than the investor who did nothing. Therefore, if you were planning to invest in equities all along and stayed away, make a start on it now.

Buying what has fallen the most

Those of us who do have the conviction to buy when the markets fall, can still be sorely tempted to buy the wrong kind of stocks or funds. The excessive amounts of data available to all of us can prove to be a big disadvantage here.

Are you running down the list of BSE stocks to see which stocks have corrected 30-40 per cent in this market fall? Well, those aren't great buys just because they've fallen like a stone. In fact, in the current risk-off phase the market is punishing precisely those companies and sectors that carry the most risk - commodity processors, highly leveraged companies, companies with foreign currency loans, companies with large global exposures. Low PEs for some of these stocks can be misleading. Their PE is being de-rated mainly because investors expect their "E" to shrink.

What declines the most also need not bounce back the most. Investors who lost money on tech stocks in 2000 or infrastructure and realty plays in 2008 will vouch for this. Therefore, if you had a conviction list of quality stocks to buy before this carnage, now's the time to stick to the list and buy the same stocks.

The same logic can be applied to equity funds too. Funds which own momentum stocks and those which are overloaded with mid and small-caps may suffer the most reverses in this correction. But buying them just because they have corrected the most would be a bad strategy, if further volatility is round the corner. If a large and mid-cap fund was your choice before this market slump, it should still be your choice now.

Turning short-termist

Another temptation that strikes us during market falls is to abandon our long-held principles in pursuit of quick bucks. Today, the list of stocks that have corrected big time on Monday features many sub-₹50 stocks. There also trader favourites from fancied themes such as logistics, auto components and pharma. Looking at the highs that these stocks have made only a few weeks ago, it may be tempting to buy some of them in the hope that they will bounce back in double-quick time, multiplying your money.

But this would be a most risky strategy to adopt. No investor, even if he has been sitting on piles of cash, has unlimited money to deploy. Given the limited investments that we can afford, we need to look for the stocks that we would never regret holding in the long term.

The same logic applies to funds too. Instead of buying smallcap, microcap or high-beta equity funds in the hope of making quick money in a rebound, it would be better to buy good quality multicap funds that you have always wanted to own in your long-term portfolio.

Equity market corrections are an opportunity to buy the stocks or equity funds that you already like, at a cheaper price. Don't change your selection criteria just because the market mood has changed.