How to deal with stock market volatililty?

My son who is 14 years old, broke his leg when he fell from his bicycle. He was in a lot of pain. I took him to the ortho doctor and got him a cast. When the doctor told that he cannot put any weight on the casted foot for 4 weeks, my son’s heart sank. How will he manage with his life for the next 4 weeks? Well, Its already 3 weeks since this happened. He still has one more week to go before the cast can be removed. He had been going to school for the past 2 weeks with crutches. I am dropping him in the school and picking him up. He will definitely feel free again once the cast comes off and he can walk normally again!

Why are we discussing this here? There is a reason. We all have been through pain when we were young. It could have been a fall, or some other thing which hurt us badly. At that time, we had been in a lot of pain and trouble. How does it feel today after several years have passed? How will my son feel when he thinks of this fracture say 20 years later? We as humans feel pain when we are going through it. Once its over, the pain goes away and we are fine again. When we go through the pain, it feels like a football. Years later, it seems like a pin fighting for space among all the memories that we have.

The pain from the current stock market fall and crash is current. What will we feel about it say 20 years from now? For sure, it would feel distant and almost forgotten. How many of us can remember the pain and scars from the 2008 stock market crash? At that time, the pain was very real and debilitating for some. What do they recollect of it now? Just as an event which happened a long time back.

Below is a performance chart of ICICI Pru Nifty fund from valueresearchonline. It shows the fund performance from 1st July 2004 to 10th March 2009. The index had crashed and lost over 55% from the peak reached in early 2008. The period from Jan 2008 to March 2009 was like the worst nightmare for an equity investor.

Now, let us take a step away and look at the the full picture as of today

The crash in 2008 and the rise in 2009 now appears a small event in the distant past. The market managed to recover most of the losses in a period of a year. An investor who had invested at the peak in Jan 2008 would have now got a CAGR of 5.7% and an investor who has invested at the bottom in 2009 would have got a CAGR of 14.9% as of now.

Goal based investing and asset allocation

Every investor needs to follow a goal based investing. I have a blog on this Goal based investing. For long term goals, the suitable asset allocation to equity is between 40% to 70% based on your risk profile. Your risk profile is based on your individual risk tolerance. In simple words it is based on your ability to withstand market volatility. At times like this, you need to revisit your risk tolerance and review asset allocation. Due to the market crash, if your equity allocation has fallen below your asset allocation, you could do a re-balancing by moving money from debt to equity to maintain the target asset allocation. Other than this, you need to remain calm with the knowledge that this too shall pass. Several years later, this will appear a small incident in your distant memory!

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