Monday, November 3, 2008

Crash is welcome!

This Crash Is Welcome

 If there is one question that everyone wants answered, it is regarding the plan of action in such market turmoil. How does one get through this crisis?  

Actually, there are just two avenues to explore. 

First, you can sell your investments and sit on cash or channelize the money into fixed return instruments. Not only is this not very tax efficient (the returns from fixed income instruments are taxed) but you also lose capital since you are selling at very low rates.

Cashing out closer to the bottom is disaster from an investment point of view. Even if you go ahead, you will not know when to begin reinvesting down the road. The odds are against you when you attempt market timing. 

Your second option, and definitely the most preferable route, is to stick with your long term plan since this crash will actually benefit you. Because in the equity market, you make money not despite the crashes but because of the crashes. 

Let’s look at the tech boom. The Sensex touched around 5900 in February 2000 before sinking to 2600 in September 2001. It touched 6000 only in January 2004.

Now let’s assume that the crash never happened. The Sensex reached 5600 in March 2000 and stayed at that level till October 2004.

If you had started investing Rs 20,000/month in a Sensex-based index fund in early 1997 and continued all through, your investments would have been worth Rs 55 lakh (without the crash) instead of Rs 66 lakh (with the crash). The reason? The crash enabled the investor to buy cheap and thus eventually raise total returns.

If you are investing steadily for the long term, then intermittent crashes help you make more money, not less. Because when bubbles correct, they usually overcorrect so that the market is selling well below fair value. So that’s the time to go buying, not selling!!!