How to invest in mutual funds during a market crash

Kavya Balaji   /   March 27, 2020
How to invest in mutual funds during a market crash

Stock market crashes aren’t uncommon at all. For instance, in March 2020, the Indian stock market investors lost over Rs. 19,000 crores because of the Coronavirus and the slide in crude oil prices. These market crashes are usually well talked about and most investors are aware of these falls. Most of the time you might read articles about how fund houses purchased stocks in the market and that helped stabilise the market losses. Now, the question is should you follow fund houses and buy mutual funds when the markets crash? You will be investing in those funds that buy stocks at lower prices. Will this be a prudent strategy? Let’s find out.

What happens to your investments when there is a market crash?

You know that most stock prices fall when the overall market crashed. When it comes to your mutual funds, the Net Asset Values (NAV) or prices of the equity mutual funds will also fall as they invest in stocks. Typically, investors either panic because their returns are beaten down or they decide to buy the funds because the NAV becomes attractive.

What if you buy funds at lower NAVs? When you buy mutual funds during a market crash, you get more fund units as the NAVs have fallen. How? Suppose the NAV of your mutual funds was Rs 12 per unit. If you decide to to invest Rs 12,000, you could get 1,000 units of the fund. Let’s say the markets crash and the NAV falls to Rs. 8. At this price, you can get 1,500 units. This is much more than what you would have got before the crash.

Should you buy mutual funds then?

Even though getting more units looks attractive, how will you know if the NAV is good enough? Does lower NAV mean that the fund is actually undervalued? You need to do some calculations here. Let’s look at two scenarios. One, where you are putting more money in a new fund and another, where you want to put more money in an existing fund.

Investing in a new fund

You need to look at the past performance of the fund and compare it to its peers. You will need to look at various factors such as the entry load, exit load, expense ratio, among others as this will determine the cost of investing in the fund. Looking at several ratios such as alpha will help you understand if the fund is undervalued compared to peers. Since it’s not possible to compare NAVs of two peer funds, the best way to choose a mutual fund is by looking at information such as Sharpe ratio, Sortino ratio and Treynor ratio. Read this article for more information – The mutual funds ratios you need to know.

Also, if the fund you have chosen hasn’t fallen as much as its peers, don’t think it’s unattractive. In fact, it might be a better fund than its peers because it has resisted a market crash. Choosing dividend paying funds whose NAVs have fallen is a good strategy if you need income from your investments.

Investing in an existing fund

Look at all the funds in your portfolio. See how they have fallen after the market crash. Look at the NAV history of the funds. Check the average NAV of the funds. Choose a fund whose NAV is close to or below its average NAV. If the NAV of the fund is below its 3-year average, you could consider it as being undervalued if the fund’s fundamentals haven’t changed in those years. However, you need to check if this fall has happened because of the market crash or if there has been a consistent fall. If the NAV has been sliding much before the crash, avoid investing in the fund and look at whether you should exit the fund. The idea is to invest in a fund that is a performer and has slipped due to the market crash alone. You can invest in the fund using the same folio if you are investing in an existing fund.

Should you invest a lumpsum or step up your SIP?

Invest a significant lumpsum only if you have a high-risk appetite. Why? Because there is no guarantee that the markets won’t fall further. Let’s say the markets have crashed quite a bit and that you invest a lumpsum in a fund whose NAV has fallen by Rs. 5. If there is a subsequent bull run and the NAV goes up, you might feel you made a wise investment. If the NAV falls by another Rs. 5, you might have to wait longer for the market to move up. So, check with a knowledgeable financial advisor such as those with before committing a lumpsum after a market crash.

The best way will be to combine two strategies of investing a lumpsum after the markets crash and continuing to invest in funds as you always do. You can choose to step up your SIP. However, this beats the whole purpose of starting an SIP which is to remain unperturbed during market crashes.

How to invest?

Since investing after a market crash is risky, it is best to use your income from investments such as interest from fixed deposits and dividends from stocks and mutual funds. This way, you won’t be stressed about putting in more money. If you are using cash from your savings account, you might be disappointed if the markets crash further. The point is always use only money that you won’t need immediately for such investments.