TLDR: Simple formula to remove emotions from investing during a recession

The maxims of investing is very simple. Invest in the market via broad based index funds over the long term by investing every month you will achieve financial independence. Sounds easy doesn’t it?

But why don’t we see millionaires all around us? I have covered this topic in some detail about why we don’t have hundreds of Warren Buffets but just one. Investing has more to do with our emotional ability to keep sustaining through the ups and downs and vagaries of the market.

The above shows my CAS statement of India investments across mutual funds, ETFs and index funds. It never is a straight line through the different months or even years. It goes up and down.

But this does not really cover a recession or strong correction scenario. How would you handle a period like that.

Pre-requisities

• 3 to 6 months expenses worth emergency fund

  • Build up your emergency fund to enable you to ride through a particularly tough or long recession. How and where do you keep your emergency funds - check this post on the details.

• Relatively stable job

  • You have a relatively stable income / job to allow you to continue investing during recessions / strong corrections

• Only long term goals

  • You have created clear goals with clear time horizons and do not need to apply the below rules to short term goals. My definition of long term goal is greater than 7 years away. See here for more details

• Continue your SIP

  • At no point you will stop your SIPs during the recession. Otherwise it defeats the purpose of this whole post. Money is made in the markets during recessions not during the bull markets. So we proceed with the assumption that your SIPs will continue going forward.

Decoupling Emotion from Investing

Why is this important? You can be the most ardent investor with clear goals and investment views. But when the market is going through a recession and every news media via TV or social media is predicting the “end of the world” it is very difficult to continue with your investments. It becomes very tempting to cut your losses when the market has fallen by 40%.

If you have survived through the Global financial Crisis of 2008/2009 you can probably relate, if you are relatively new to the investing world and all you have seen over the last 10 years is this longest bull run in recorded history it is very difficult to see the other side, because of recency bias.

The best option that you have is to decouple emotions out of investing by automating or using a formula to achieve it.

Building up a war chest

How do you take advantage of a bear market or recession?

By investing more and averaging down your cost of purchase.

It goes without saying that you continue your SIP, but try and build up a war chest of cash positions to take advantage of the market conditions.

Where will this cash portion come from

• Bonus

  • If you receive an annual performance bonus, put a portion of this way towards your war chest - what percentage, that is really up to you

• Increments

  • Your salary goes up annually?, then put away a part of the increments towards this war chest, again what portion is up to you

• Re-aligning portfolio

  • If your typical monthly SIP is say 70:30 (Equity:debt) and you see the market run up and become overheated, try to re-align your portfolio. Move to a 60:40 (Equity:debt) or even a 50:50 (Equity: debt) split. The additional 10 / 20% that you have moved towards debt, tag that as an war chest to be deployed during market corrections

  • I use Kuvera.in’s goals feature to create a war chest goal to add towards this, ready to deploy in case of recession / correction

  • Do not stop SIP or reduce the investment amount, tweak the ratios only.

How big a war chest

There is no point in keeping money as cash, it is better deployed as FD or liquid funds as you see fit so that you are getting returns which are slightly better than inflation and not losing money by keeping it in a low yield savings account in a bank.

So you are building up this war chest over the last several months or years. How big a war chest do you need? Again, it is really dependent on your risk profile and appetite. If you are saving towards a long term goal like retirement or child’s education, create the war chest as a percentage of your target goal.

Say your goal is to save 50 Lakhs (5 million) for your child’s education goal in 10 years. Then your war chest can be 7.5% to 15% of the goal, so anywhere between 3.75 to 7.5 Lakhs.

If you have a similar goals for retirement, buying a house, college fund etc and all these goals are greater than 7 years away. You can build a overall war chest of 7.5 to 15% of the total of all the goals.

Do not keep this 7.5 to 12.5 % in a bank account, invest in fixed deposit (FD) or debt mutual funds via liquid funds. So your war chest will keep up with inflation or slightly better than inflation

Correction/ Recession investing

It is a simple formula that can be applied during strong corrections as below

% benchmark index correction = 2 X percentage increase in monthly SIP

Simple isn’t it?

Example

If you are investing say 30,000 in equity (NIFTY 100) and 20,000 in debt every month via SIP.

a 5% fall in NIFTY 100 = 10% increase in equity SIP (33,000 monthly)

a 10% fall in NIFTY 100 = 20% increase in equity SIP (36,000 monthly)

and so on.

Conclusion

You can do this incremental investing by starting a second SIP in the same funds that you are already investing in. This way you tweak and update the SIP without touching the main SIP. You could also stop the second SIP with the markets reached the same previous highs. If you can make this decision by a simple formula instead of letting your emotions take over your decisions you will meet your goals easier and faster

Happy Investing.

Title Image : Flickr