The spread of Covid-19 since early 2020 brought an unexpected outcome - retail participation in Indian equity markets saw a sharp jump. According to official data, around 26 lakh new demat accounts were opened in 2021-22. Similarly, the number of unique investors in Mutual Funds in India went up by 49% in 2021-22, compared to the previous year. A lot of this growth coincided with the rapid rise in Indian equity markets between 2020 and mid-2021.

Since October 2021, however, the equity market has witnessed a gradual decline. As of early July 2022, the S&P BSE Sensex has come down 13% from its peak seen in October 2021. This correction was largely on expected lines but for those investors who are new to investing, the decline in the equity market came as a rude shock. Investors who entered the market over the last two years have largely seen an upward-trending market. But that is not the nature of the equity market – a fact new investors are learning in the present market conditions.

Corrections are part of usual market cycles

If you are an investor worrying about the fall in the equity market and its impact on your portfolio, this is a good time to understand that corrections are a part and parcel of the equity market. A complete market cycle consists of various phases – bull, bear, and sideways market. Corrections can be triggered by a plethora of domestic and international factors. For example, in 2008, the subprime crisis led to a market crash all over the world, including India. The equity return that year was negative (-)51%. However, in the very next year itself, when economies recovered, the market rallied by 78%.

Then, not very long ago, in 2020, the equity market corrected over 40% within a few weeks and then quickly recovered to march to new highs. There are many more such examples. This clearly shows that equity investing is not a one-way journey. There will be ups and downs, but no one can predict how long these cycles may last. At such times, what is important to watch for is what are the things that an investor can do in times of uncertainty in equity markets.

Asset Allocation to the rescue

If you are invested only in equity, you will likely feel immense heat in situations like the current one when markets are under pressure. On the contrary, if you diversify your investments to other asset classes like fixed income or gold to some extent, the overall impact on your portfolio could be less severe.

We took the example of how equity performed in 2008 and then in 2009. What also needs to be noted is the performance of debt instruments in those two years. In 2008, when equity crashed, returns from debt instruments were at 28%. In 2009, when equity reclaimed its lost ground, debt gave a return of negative (-)9%. Similarly, in 2020, there was a rapid jump in gold prices as equity markets globally corrected.

These examples point to the fact that different asset classes behave differently in any given situation. Accordingly, you should always have exposure to different asset classes to take advantage of the changing dynamics and also to hedge your investments to a reasonable extent.

What should you do?

With ongoing geopolitical developments like the Russia-Ukraine conflict, high inflation, and rising interest rates in India and abroad, the near-term outlook for the equity markets remains uncertain. For those who have never thought about asset allocation, this is a good time to set your asset allocation in order.

Typically, those having a high-risk appetite or those with a longer investment horizon can consider a higher allocation to equity and a lower allocation to debt investments. On the other hand, those closer to retirement or who have a low-risk appetite can maintain a lower equity exposure.  

If you are unsure about doing all this on your own, you can opt for a dynamically managed asset allocation scheme or multi-asset funds. Here, based on the changing market conditions, the fund manager will vary the fund’s equity and debt allocation. In other words, fund managers will help you navigate through volatility effectively.

To conclude, when investing during volatile times, stick to one’s asset allocation. Use the opportunities available to enhance one’s investment wherever possible.

The views are personal and are not part of the Outlook Money editorial Feature

S Sridharan, Founder & Principal Officer, Wealth Ladder Direct