While mutual funds are one of the most popular choices among investors, it is largely dependent on the stock markets and thus always has a risk of serious fluctuations or even a crash. No matter how hard we prepare, we can not always predict a crash, but we can definitely protect our portfolio in order to have minimal impact from it.
Even the most patient investor can get scared during a crash, for example when the pandemic hit and the markets lost over 20 percent in just one session and the further downside was expected. So what should a mutual fund investor do at such times of crisis?
Most experts advise against redeeming mutual fund units or closing accounts during times of volatility or crash.
An investor should always be prepared for a crash. While creating a portfolio, the investors should take basic steps like diversifying the portfolio, investing in long-term instruments, investing in bonds, etc in order to provide a cushion from the market fluctuations.
However, there are certain steps an investor can take to protect his/her mutual fund portfolio after a market crash.
1) Adding more bond funds: Generally, when markets and bonds have an inverse relationship. So in case of a market crash when the equity funds decline, the presence of more bond funds can cushion the loss. Also, bond funds are considered safer since they generally provide guaranteed returns. So in case of a crash, you can increase the weightage of bond funds in your portfolio to protect from further volatility.
2) Asset allocation strategy: No two assets perform in the same way. Like in the case of a market crash, gold prices surge since it is considered a safe haven. So an investor must have multiple assets in his/her portfolio. He/she can also re-check and rebalance the asset allocation strategy after a crash to protect from any more damage.
3) Investing through STP instead of Lumpsum: If you as an investor, invest in mutual funds through lumpsum. It is important for you to reconsider in case of a crash. When the markets are in a slump, your entire corpus will be affected. So instead of a lump sum, an investor should consider investing through an STP (systematic transfer plan). In this, you invest your lump sum in a debt fund and it gets transferred to an equity fund in SIP mode. So, even if the market crashes, your lump sum amount is not impacted much.
4) Invest through SIP: SIP investment always generates more wealth due to the power of compounding. Also, in case of a crash, you can buy more units in the same SIP amount than in other months. This in turn helps in averaging out the price and lessens the impact of the crash.
5) Balanced Funds: Investing in more balanced funds which invest in a variety of stocks can also protect your fund portfolio during a crash. Smallcap and midcap funds are generally more affected by the crash, so if your fund portfolio has a high weightage in large-cap stocks, the impact will not be as massive as that in small and midcap stocks.
These are a few steps you can take in order to protect your mutual fund portfolio in case of a crash. However, as the famous saying goes: precaution is better than cure, the same applies to your portfolio. Make sure your portfolio is well-diversified and has weights in different assets from the start. This can help you trim your losses in any case of a market crash.