Investors began to look to the stock markets for income after the pandemic, as it shifted their primary source of income. This is reflected in the number of trading accounts which has almost doubled over the past two years. In addition, the share of retail trade in trade volumes has increased from 39% at the start of 2020 to 45% today. The type of optimism that prevails in the market has to do with a psychological concept of FOMO vs FOLO – the fear of failing versus the fear of losing.
Let me explain this with a simple example; you are offered a coin toss bet. If the coin shows heads, you lose Rs 100. If the coin shows heads, you win Rs 150. Is this bet worthwhile? Would you accept it? The expected value is derived from the probability multiplied by the gain or loss. In this case, the odds-adjusted result is positive because you might win more (Rs 75) than you can lose (Rs 50) resulting in a net gain of Rs 25. However, many may still reject this as the fear of losing. Rs 100 is more intense than the expectation of earning Rs 150, indicating risk aversion (loss) behavior. Now what is the payout you need to balance an equal chance of losing Rs 100? For the most part, the answer could be Rs 200 or more. And, anything above Rs 200 would indicate risk-seeking behavior, as the fear of missing out on a win outweighs the fear of losing Rs 100. In both scenarios, the net profit adjusted for probability is positive. for the person who accepts the bet. This is currently happening with the stock markets.
Markets go through different cycles. At the start of 2020, fear of losing money and risk averse behaviors were much more prevalent, leading to a market slowdown. After that, renewed investor optimism led to a shift in investor behavior towards FOMO. Consider this year’s IPO market. For most shows, the retail subscription was much larger than expected, as in an uptrend market one would weigh more on the fear of missing out on potential listing gains than on the fear of losing if the price price is lower than the issue price. .
Equities are benefiting from expectations of an economic rebound driven by a massive fiscal stimulus focused on granting credit, improving farm incomes and attracting exports. Few other auspicious factors are capital spending, direct foreign and portfolio inflows, low cost of credit, and expectations of increased consumer spending as vaccines are rolled out and economies reopen. These growth engines should help businesses improve their bottom line. However, in the near term, few factors persist – the potential impact of a third wave, high inflation and valuation concerns. Investors should be aware of the downside potential resulting from additional or above normal exposure to growth assets (equities) and continue to assess these exposures to ensure that they properly balance risks.
How can investors get through this period? The current market cycle makes the multi-asset investment approach much more relevant to generate better long-term risk-adjusted performance. Evaluating adequate exposure to stocks in a portfolio to achieve a certain investment objective is essential, as a higher allocation could expose an investor to the risk of capital loss if the markets were to correct. Investors might also consider diversifying their exposure to equities by investing in international markets. This helps by providing hedge against the depreciation of the rupee and an opportunity to gain exposure to various international economic and fundamental growth drivers outside of Indian equities.
Deny short term market noise and avoid falling into the FOMO vs FOLO trap as this can have an unwanted outcome on your investment goal. Instead, investors should stick to their financial plan. Investors entered the market with specific goals in mind, whether that be to retire many years in the future or to focus on shorter-term aspirations, such as buying a home. or a second car. Whether the market is at a high or low, your financial plan probably hasn’t changed much, and your initial portfolio choice based on your financial plan might still be right for your goals.
(The author is Associate Director, Capital Markets and Asset Allocation at Morningstar)