Stock market crashes by 10,000 points – What will you do now?

What’s happening to the stock market?

The stock market indices world over are having a free fall.

The Indian barometer, Sensex, too has shed over 1600 points in just one day, which is a close to 6% drop in its value.

Why? Many pundits are busy deciphering the reasons but in this complex world, it would not be easy to find out what exactly has led to this.

In “Against the Gods – The Remarkable Story of Risk“, a book by Peter L. Bernstein, he mentions that a flutter of a butterfly can cause a typhoon halfway around the world. This is an example of the Chaos Theory. If we stretch the argument further, the flutter could have happened half a million years ago and caused the typhoon today.

So, the reasons are anybody’s guess.

I believe that while this stock market crash was a big event – it is being touted as the 3rd biggest fall ever in a single day – it may not be the end. But a beginning, of a bigger crash event.

Beware: I have no credentials to forecast or predict, just making random guesses. I mention it only to raise an  important question.

My question is “what will you do when the Sensex, the index of stock market crashes further, not by another 1,000 or 5,000 points but, hold your breath, 10,000 points?”

10,000 points – Oh God! What is going to happen to my portfolio?

Well, for starters, you might be scared to even look at your equity portfolio. Because if you do, you will be looking at a lot of RED (read losses). All your stocks and equity mutual funds will be cliff hanging, crying for life.

You will oscillate between greed and fear. The two devil emotions, which if not controlled, can play havoc with your money.

Warning: If you are not accustomed to stock markets’ ups and downs, then you are likely to be manipulated by your own mind and the so called experts, the TV pundits.

Your own first instinct will be to sell. In my humble view, if you are selling just because markets are going down, you are making a huge mistake. Don’t fall for the profit booking argument too.

Do you want to know when should you sell or book profits? Read here.

So, what should I do now? 🙁

First, take note of your asset allocation (the spread of your money across asset types, namely, equity, bonds, real estate, gold, cash). Most likely, it will change. In fact, quite a bit.

Suppose you had 50% of your money invested in equity (true for very few investors). Post such a massive drop, your allocation to equities would now be down to about 35%, that is a 15% less than the decided allocation. This is a decrease of about 30% in the value of your equity portfolio.

So, if your equity portfolio is valued at Rs. 10 lacs, that means it is now worth only Rs. 7 lacs – Rs. 3 lacs wiped off.

But if your overall portfolio is valued at Rs. 25 lacs, then post the crash the total portfolio is down to Rs. 22 lacs – a decrease in value of 12%.

The rules do not change

You may have read a lot about making the highest returns, gaming the markets, on investment management,  beta, alpha and gamma, all the possible jargon that the financial industry can throw at you.

At the end of the day, the thing that matters the most is Asset Allocation.

Studies have shown that asset allocation is the single biggest determinant – in fact over 90% – of the performance of your portfolio. It deserves all your focus and attention. It simply means this –

• When markets rise and it increases the allocation of equities in the portfolio, then you shift money out of equities and move into other assets like debt mutual funds, fixed deposits, etc.
• When markets fall, you adjust the allocation by moving more money from your other assets into equities.

Let’s consider our example again – If you are ready to swear by the principle of asset allocation, then it would demand that you restore your allocation to equities to the original 50%. Move out money from your other assets into equities, so that the proportions look the same as before.

The core idea is simple:

Maintain the asset allocation that you have decided for your portfolio based on your goals and risk tolerance. 

The guiding principle of this core idea is ‘control your behaviour – your greed and fear‘.

How do you control your behaviour?

The answer is a boring one. Be prepared. Recognise that such events will take place and you have to plan your response to them.

Here is a pro-tip: Write down on a piece of paper the question and the answer to “what will you do when the markets fall sharply?”

The answer could be something like:

I will be guided by my goals and nothing else. I will not panic and not sell just because everyone else is doing so. I will check my goals and my asset allocation and if it has changed more than (+) or (-) 10%, then I will adjust it to reflect the current realities. 

And whenever an event like “the crash” takes place, you have your own words to heed to. If you haven’t written one, write it now. You may need it soon.

Note: If you think you cannot do it by yourself, that is manage your emotions and stick to your asset allocation, then hire an investment advisor who can be your guide in such turbulent times. Yes, that’s what advisors are really for and not just for telling you the next hot investment tip.

What is the actual possibility of the markets crashing by 10,000 points?

It has happened in the past. Remember January 2008. So, it cannot be ruled out that it will not happen again. It can, it possibly will.

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Between you and me: What will you do when the market crashes 10,000 points? I look forward to your comments.