2022 has been a rocky year so far. Stocks and cryptocurrencies have corrected sharply, and there is very little sign of recovery. Inflation is running high, and there are fears that the central bank cannot calm the inflation without running the economy into a recession.

Nifty is down 15% from its high. Market analysts and economists are forecasting further pain in the short term. You are probably feeling anxious looking at your portfolio. Wondering if you should sell your holdings or continue to buy more. You are not sure if you are staring at an opportunity of a lifetime or a catastrophic mistake.

We have good news and bad news for you. The bad news is that we do not know where the market is headed. In fact, nobody does. And the good news is that with a proper strategy, there is a way to turn this short term volatility to our advantage. And we will see how.

A year ago, we were discussing and speculating stocks and sectors that would return 20%, not in a year or a quarter but in one month. And now, we are worried if the stock markets will produce positive returns this year. How times change!

2021 was a great year, wasn’t it? Anything you bought went up 20% or 30% in a few weeks, and if a stock didn’t multiply by 2x or 3x in 6 months, it was a matter of shame. Several investors and stock traders took birth during this period. People in their 20s and 30s quitting their jobs to become full-time investors or traders.

It is easy to perform a postmortem of historical events and claim that the signs of a bubble were present all along. But it is difficult to spot a bubble when you are in one. Even Alan Greenspan, the former chairman of the Federal Reserve, agreed, “It is very difficult to definitively identify a bubble until after the fact—that is, when its bursting confirmed its existence.”

Risk is inevitable in anything we do. One way to think about investing is as negotiating risk in pursuit of profit.

The risk in investing doesn’t come primarily from the economy, businesses, or other geopolitical factors. It comes from the behaviour of the market participants. When investors are exuberant their overenthusiastic buying drives the prices to dangerous levels. When they’re depressed, the panic sale pushes prices down to irresistible levels.

This leads to volatility in the markets. Volatility is not necessarily bad for investors, especially when their investment horizon is long (5 yrs or more).

“Wind extinguishes a candle and energises fire. Likewise, with randomness, uncertainty, and chaos: you want to use them, not hide from them. You want to be the fire and wish for the wind.”

—Taleb

According to Taleb, all systems can be classified as either fragile, robust, or Antifragile.

Fragile: Breaks under stress.

Resilient: Resists shocks and stays the same.

Antifragile: grows stronger under stress (or shocks).

To understand this better, let us take the example of 2 brothers, Ram and Shyam. Ram is working at a large multinational corp in India, and he has a steady income of Rs. 50,000. On the other hand, Shyam runs a restaurant, and his income is highly variable. During good times he earns around Rs. 70,000 after paying the expenses, and Rs. 30,000 when the business is down. The average income for the year, however, is approximately the same for the brothers.

Their parents, and sometimes Shyam himself, wishes he had the job security and stability of his brother Ram. Although Shyam enjoys running his restaurant, the randomness of his income worries him.

Shyam is not alone here. There is this illusion among all of us that randomness is risky. And we should eliminate randomness from our lives and seek stability.

During the covid-19 pandemic, the firm Ram worked for had to cut down the staff to reduce expenses, and Ram found himself jobless in the middle of a recession.

Shyam quickly pivoted his restaurant to a cloud kitchen and offered home delivery. His income more than doubled during the lockdown.

Employees have no volatility in their income, but they can be surprised to see their income go to zero with just a phone call.

Ram has one large employer; his risk is heavily concentrated. Shyam has many small customers, and through pricing, he can select the ones that fit him the best. Therefore, his risk is diversified.

Randomness is inevitable in life. Business earnings are not steady, and their profit margins are not steady. Man-made smoothing of randomness produces the equivalent of Ram’s income: smooth, steady, but fragile.

Shyam was able to survive the shock because his business, although volatile, was antifragile. By making small variations, he was able to adapt his business to a new environment.

“One career has the illusion of stability but is fragile; the other has the illusion of variability but is robust and even antifragile.”

You don’t have to surrender to stock market volatility and wait for things to get better. Building antifragile systems will help you take advantage of this current market drawdown and grow your investments. Here’s how you can do it:

Keep a long term view, and go aggressive on your SIPs. If you are new to investing, begin your journey with a low-cost index fund of Nifty 50 or Sensex and invest a fixed sum regularly. The markets will eventually rebound, so don’t miss out on the opportunity to grab the discount sale.

P/E or Price/Earnings ratio helps one determine if the underlying security is overvalued or undervalued. As you can see from the PE Ratio Heat Map above, Nifty 50 was overvalued at the beginning of 2021 and has begun cooling down since. Currently, the Nifty is trading at a PE of 20.5, making it attractive as an investment. Don’t get me wrong, there have been instances in the past when the Nifty has fallen below the 20 PE mark, and we may very well witness the same in the near future. Since we cannot time the market to catch the bottom, Sip is the most prudent approach.

Investing regularly and consistently is the best way to ride out volatility and grow your long-term investments.

Build a diversified portfolio of index funds, gold, cash, fixed-income securities (bonds) and real estate. I am tempted to include cryptocurrencies in the list. But since most people have a low to medium risk profile, you are better off avoiding investments in cryptocurrency, at least until the regulations and tax rules are made clear in India.

The ratio in which you should diversify your investments depends on your risk profile, age and other factors. The ideal asset allocation

For someone in their 20s with a moderate risk profile: 60% equity, 15% bonds, 15% REITs and 10% Gold.

For people in their 50s with a low-risk profile: 30% equity, 40% bonds, 15% REITs and 15% Gold.

Likewise, the rules of diversification depend on your age, risk profile, country etc. If you want to simplify your diversification rules, here’s a rule of thumb you can follow:

Prepare an investment strategy and stick to it. While the future may seem gloomy, don’t forget that a recession is always followed by a recovery. 

Disclaimer: Please do your own research before investing. The purpose of this blog is for informational purposes only.