How to Manage Mutual Funds During Market Volatility?

When the market is volatile, many investors, especially the new ones, panic and sell their holdings. Even investors who entered the market with a long-term vision start to doubt their strategy and investment rationale. Investors must know that market volatility is inevitable - you cannot escape it if you decide to play the investing game. However, you can learn to ride it. But what exactly is market volatility, and how can you manage your mutual funds in such times? We answer these questions here, so continue to read.

What is Market Volatility?

Market Volatility refers to the degree of variation or fluctuation in the price of a mutual fund (or any other asset) over a certain period. In other words, it measures how drastically prices move up or down in a given time frame. Higher volatility means prices swing widely and unpredictably, while lower volatility indicates more stable, gradual price changes. Volatility is an indicator of market risk—when volatility spikes, so does uncertainty and potential risk for investors.

Volatility can be measured using various metrics, but the most common is standard deviation, which calculates how much prices deviate from the average over a specific period. Another popular tool is the Volatility Index (VIX), often called the 'fear gauge', which reflects expected market volatility over the next 30 days.

Factors Causing Market Volatility

The list of factors that can cause market volatility is long. Let us look at some of the key factors:

1. Economic Data and Indicators: Regular economic reports, such as unemployment figures, GDP growth, inflation, and interest rates, have a significant impact on market movements. Positive or negative data can lead to sharp reactions from investors.
2. Monetary Policy and Interest Rates: The decisions made by central banks (the Reserve Bank of India) about interest rates can significantly impact market volatility. When central banks raise interest rates, borrowing costs increase, which can slow economic growth and corporate profits, causing stock prices to drop.
3. Geopolitical Events: Events like wars, political instability, trade conflicts, or major elections can create uncertainty in the markets. Uncertainty often leads to volatility because investors react emotionally and unpredictably. At present, we see market volatility high because of the ongoing war between Iran and Israel.
4. Global Economic Events: Global events, like pandemics, natural disasters, or significant economic downturns in large economies ( the Eurozone crisis, China’s economic slowdown, etc), can lead to widespread volatility as global markets are interconnected.

How does mutual fund get affected due to market volatility?

Mutual funds are directly impacted by market volatility because their performance is tied to the underlying assets in which they invest. In periods of market volatility, the value of these assets—whether stocks or bonds—can fluctuate significantly, causing the Net Asset Value (NAV) of the mutual fund to rise or fall sharply.

Equity mutual funds, which invest primarily in stocks, tend to experience the most pronounced impact during volatile times, as stock prices can swing wildly due to economic events, market sentiment, or geopolitical factors. Bond funds, though generally more stable, can also be affected by interest rate changes or credit risk concerns during market turbulence. Additionally, market volatility may cause investors to react emotionally, leading to large inflows or outflows from mutual funds, further affecting their performance.

How to manage Mutual Funds during market volatility?

Managing your mutual fund investments (or any other asset) during periods of market volatility can be tricky for investors. The good news is that, with the right strategy, you can navigate the ups and downs without panicking or making impulsive decisions. Here are some tips to help you manage your mutual fund portfolio during volatile times:

1. Do Not Panic: As mentioned earlier, market volatility is part of the game, and there is not much you can do about it. You should be prepared for it and do not panic when it happens. As you begin investing in mutual funds, it is important to set clear financial goals and create a well-thought-out investment plan. Do not let short-term market fluctuations derail your long-term strategy.
2. Continue Your SIP: Another good news is that you can make market volatility work for you. How? Follow the basics - invest in a mutual fund via a Systematic Investment Plan or continue your SIPs. SIP is an excellent way to manage mutual fund investments during volatile periods. With SIPs, you invest a fixed amount regularly, regardless of the market’s ups and downs. It allows you to average your purchase cost over time, benefiting from both market highs and lows. Continue your SIPs even during market downturns. In fact, when the market dips, you buy more units at a lower price, which could increase your returns in the long run when the market recovers.
3. Rebalance Your Portfolio Periodically: During periods of high volatility, your asset allocation can shift from your intended balance. For example, if equity funds fall sharply, they may take up a smaller portion of your portfolio than planned. Regular portfolio rebalancing can help you realign your investments with your original risk tolerance and goals. Review your portfolio every 6-12 months and rebalance if necessary. If your equity allocation has become too low due to market declines, consider rebalancing by buying more equities and vice versa.
4. Consider Shifting to Less Volatile Funds: Not everyone can ride the market volatility, and if you have figured that out, you need to act accordingly. If market volatility makes you too uncomfortable, it might make sense to shift some of your equity mutual funds into less volatile options like debt or liquid funds. These funds tend to be more stable during turbulent markets and can protect your capital from large swings.

Benefits of managing mutual funds in market volatility

Here are some of the benefits of proactively managing mutual funds during a volatile market:

1. You Get to Buy at Lower Prices: Market downturns often cause the Net Asset Value (NAV) of mutual funds, especially equity funds, to drop. It creates a buying opportunity for you to continue to invest or increase your investment during volatile times. By purchasing mutual fund units at a lower NAV, you benefit when the market recovers, potentially increasing your returns.
2. Rupee Cost Averaging with SIPs: SIPs are designed to take advantage of market volatility by employing rupee cost averaging. When markets fall, the fixed amount you invest buys more units, and when markets rise, it buys fewer units. Over time, this helps in averaging the purchase price of your mutual fund units and reduces the impact of market volatility.
3. Potential for Higher Long-Term Returns: Volatility creates both risks and opportunities. By staying invested and managing your mutual fund portfolio wisely, you allow your investments to participate in market recoveries, which often follow periods of high volatility. Historically, markets have rebounded from downturns and rewarded patient investors with higher long-term returns.

Before you go

Market volatility is inevitable, but how you react to it can make a big difference in your mutual fund investments. Staying calm, focusing on your long-term goals, diversifying your portfolio, and continuing SIPs can help you manage your investments effectively during turbulent times. With a clear strategy and a bit of patience, you can weather market volatility and potentially come out stronger in the long run.