Optimising Mutual Fund Investments During Stock Market Corrections

If there’s one thing that investors often fear, it is a stock market correction. However, contrary to popular opinion, a market correction is not always doom and gloom. In fact, it can be a good time to make new investments or optimise existing ones. 

While this may be true for investments like equity stocks, how about mutual funds? Can you optimise mutual fund investments during market corrections to ensure that they stay protected? This is exactly what we’re going to be looking at in this article. But before we move on to the section, let’s first try to understand the meaning of stock market corrections.   

What Is a Stock Market Correction? 

A stock market correction is the term that traders and investors use to refer to a temporary decline in the value of the overall market, which is often represented by broad-market indices like the Sensex or the Nifty 50. For a decline to be termed a correction, the value of the market needs to fall by at least 10% from its most recent high. 

Market corrections are a natural part of the cyclical nature of the stock markets. Generally, such corrections are short-term in nature and last only for a few weeks. Once the market corrects itself, it usually stabilises and starts recovering once again. This is in contrast to a bear market, where the fall in the value of the stock market is more substantial and prolonged, lasting for months. 

A stock market correction may be triggered by a plethora of different factors. These include economic slowdowns, geopolitical events, shifts in investor sentiment and concerns regarding certain sectors. Here’s an example of a stock market correction. 

Suppose the Nifty 50, a popular broad-market index, is at an all-time high of 21,700. Due to an economic slowdown combined with a geopolitical crisis between two major powers in the world, the index falls by around 3% in a day. Over the next few days, the index continues to fall. By the fifth day, the Nifty 50 had shed around 2,200 points from the all-time high of 21,700, recording a fall of about 10.13%. Since the decline in the value is more than 10%, this could be termed as a stock market correction. 

Market corrections can be of two types – time correction and price correction. Let’s compare time correction vs. price correction to better understand these concepts. Time correction, also known as market consolidation, occurs when the market moves within a particular range with no clear direction. Price correction, meanwhile, occurs when the market declines steeply like in the example mentioned above. 

How To Optimise Mutual Fund Investments During Stock Market Corrections? 

Now that you know what market correction is, let’s look at how you can optimise your mutual fund investments during such periods. 

• Purchase More Units 

Although this may sound counterintuitive, it is one of the best ways to optimise your mutual fund investments. Corrections are often temporary and the market almost always stabilises and recovers after a brief period of downfall. Therefore, whenever you’re faced with a stock market correction, you can use the period to accumulate more units of your mutual fund. 

Due to the fall in the NAV caused by the correction, you may even be able to get them at highly discounted prices. However, this method works best only if you have a long-term investment horizon since the recovery from such steep falls may take time. Here’s an example of how this method can help you optimise your mutual fund investments. 

Assume you have around 400 units of an equity mutual fund. The current NAV of the fund is ₹125 and your average cost of investment is ₹120 per unit. Due to a deep stock market correction, the NAV of the fund falls to ₹115. You use this opportunity to purchase 200 more units of the fund. This brings your average cost of investment down to ₹118 per unit. Since you now own more units of the fund, your returns will also be higher once the market recovers and the fund’s NAV goes back up to ₹125 or more.   

• Make New Investments 

Stock market corrections often present new and unique investment opportunities. For instance, it may make high-quality mutual funds with traditionally high NAVs more accessible and affordable to a larger segment of investors. In such cases, you may consider making investments in such funds. 

• Diversify Your Portfolio

As you may already know, diversification is one of the best ways to protect yourself from market downturns. Diversification works on the principle that not all sectors or asset classes may be negatively affected during stock market correction and that the outperformance of a few sectors will nullify the fall in the value of the other sectors. 

Investing in a mutual fund with a diversified mix of assets like stocks, bonds and other securities should help reduce the impact of a stock market correction. On the other hand, if you’ve already invested in a mutual fund like an equity mutual fund, consider investing an equivalent amount in debt funds. This may help soften the fall in your investment portfolio value during market downturns. 

• Invest Through an SIP 

A SIP or a Systematic Investment Plan is an investment method where you invest a small sum of money regularly in a mutual fund over a certain period. When you invest in a fund through a SIP, you get to utilise the power of rupee cost averaging, which reduces your overall cost of investment in the long run. For instance, a SIP purchases more units when the markets are falling and fewer units when the markets are rising. With a Systematic Investment Plan, you don’t have to worry about stock market corrections or timing your mutual fund purchases. 

• Rebalance 

Rebalancing your mutual fund portfolio periodically can ensure that you continue to maintain your desired level of diversification throughout. This can come in very handy when you’re faced with a stock market correction. In addition to helping you maintain a diversified portfolio, rebalancing also has other benefits like maintaining the right level of risk and even enhancing your returns. 

• Reallocate Your Mutual Investments 

Temporary reallocation of mutual fund investments involves transferring funds from one mutual fund to another for a short period. This is another great way to protect your investments from the effects of market downturns. If there’s an impending stock market correction and you’ve invested in an equity fund, you could consider reallocating your investments to a debt fund temporarily; at least until the stock market stabilises and begins to recover. Once the market recovers, you can move your investment capital back to your preferred equity fund.  

Conclusion

As an investor, you must now know what market correction is and how you can optimise your mutual fund investments when faced with such situations. Remember, market corrections are temporary and are a normal part of investing. Reacting emotionally or in a panic during such times can derail your progress and set you back from achieving your goals.

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