What to do with your money during a war!

Well, after today, we won't face too many war-like situations in the world (hopefully), so let's change the topic to make it more general.

Planning your investments during major world events

In the last few weeks we have been asked multiple times what should we do in the current market scenario. So, we thought of giving a basic investment framework, which can help navigate the turbulent time.
In today's post, we will tell you how to analyze events happening around the world and how to make any investment decision based on them.
Let's look at a step-by-step process to do this.

Step 1: Deep dive into what's happening in the market today.

Russia has invaded Ukraine. 

Are they trying to reduce NATO's control in the east? Are there other Russian motives related to the oil pipelines going via Ukraine to the EU? We don't know what the Russians want.

But the fact is that on Thursday last week, they invaded Ukraine and bombed institutions, inadvertently killing civilians. It is no longer a cold war outlook, Russia has drawn first blood.

Step 2: What is the impact or consequences of this event? 

As this is a complicated event with no sure-shot outcome, we create an optimistic and pessimistic view on this. Keep in mind that I have only done basic research and I have no in-depth background on the geopolitical situation. 

Optimistic View:

This was the maximum force Russia will apply, and the other countries only imposed sanctions without reacting further. Ukraine decides to retreat without fighting much. 

Within a few weeks talks would take place and the situation would de-escalate. Once that happens, the sanctions may be lifted again and we head towards a new normal.

Pessimistic (but still realistic) View:

Ukraine fights and asks for help. NATO retaliates. Maybe a country like the US sends peacekeeping forces into Ukraine to help fight Russia.

The situation escalates leading to a battle/war that drags on for a few months. 

Based on this, we can foresee the consequences to our economic environment. Whether a pessimistic or optimistic situation happens, the consequences will be there in varying severity. Let's list out some of them:

1. Trade stops completely with Russia and prices of everything that Russia exports (mostly oil) go up and it leads to inflation of all goods.

2. Fed does not go ahead with the planned rate hike of March and delays it during this uncertain period of inflation.

3. India could either not trade with Russia or it could trade with Russia but face sanctions from NATO. Either way, India's GDP is going to be impacted negatively.

4. Manufacturers and suppliers, therefore, lower the production capacity of goods & reduce inventory for non-essential goods. This would lead to a supply shock whenever the war ends driving prices even higher.

Once you are done thinking out the various effects this could have on the economic environment, we now come to the most important step. Create a plan of action for your investment capital.

Even if you could not create a very accurate or deep set of consequences, don't worry. Because even the best thought-out ideas can go wrong. The plan of action you make is meant to overcome just this.

Step 3: Create a plan of action

Take your total Equity investment amount (eg 1L) and divide it into some installments. Let's say 4 installments of 25k each. 

Now, we assume that at the current price of the index, the market has already given an initial reaction to the event. So now we can invest 1 installment in the Nifty Index, at the current price. Friday closing price is Rs. 16,660 for Nifty50.

Step 4: Stick to the plan!

From the invested price, you will not invest more till you see a major movement in the market or a major change in the event. With this framework in mind, let's take a look at the 4 scenarios that can take place, and how to invest in those scenarios.

Scenario 1: Market moves down significantly 

If the market corrects 10% from your reference price ie. come down to 15,000 levels, then we can go on to add another installment.

Scenario 2: The event has worsened

In such a case, we don't know at what price the market can stabilize post the change in the event. Give the market a few days' time to stabilize before investing. at a new reference point.

Scenario 3: Market moves up significantly

Every time the market moves up by 10% from its previous bottom (last installment) that is an indicator that the market has recovered from the event. Maybe the event is not as significant as you expected it to be or it might get over soon. 

Now is a good time to add a second installment as you have already built a buffer profit of at least 10% (on considering only 1 installment). However, you should not invest in all installments yet as the event is still not over.

Scenario 4: The event has become better

In such a case, you should invest 1 more installment as the market will start to recover due to this news. Further investments can be made periodically like every 1-3 weeks or follow your normal investment strategy. 

What this plan does

• This plan limits your downside. In case of a black swan (rare) event where the market drops by 30-40%, your loss is only 5%-15% of that at the portfolio level (depending on how many installments are added)
• This plan helps you stay in control and gives you a reference, even when the whole world seems to be in chaos and market volatility is very high.
• This plan reduces the subjectivity in your investment strategies. It instead gives you a process to follow for all future events, so that you do not need to rely on luck or judgment.

When should you use this

1. This strategy is good for investing in the Index. However, it does not eliminate risk from investing in individual stocks. We have seen good stocks fall by 40-50% when the index moves barely 5-10%.

The index price movement is a better indicator of how the market feels about an event, rather than any individual stock. Hence you should use this only on the index.

2. Another thing to keep in mind is that when you have completed Step 2 ie. mentioned the consequences of the event, you will realize the significance of the event.

If the event is not significant or does not bear many economic consequences, then a plan like this is of no use. The market won't move enough. In such cases, you should stick to your normal investment strategy.

What is the downside?

The downside of this strategy is that all your money is not invested. This leads to a reduced upside. Let's say the market instantly recovers from the event within a week. So while the market gained 10%, you only gained 2.5% at the portfolio level (assuming 1 installment invested).

On the whole, we feel it is better to be safe and limit your downside than get greedy and invest too much too quickly. 

If you are investing in any other strategy irrespective of Index level then you should stick to that process. In the end, the process produces better results than Ad-hoc decisions in the long term. The important aspects of the process that you need to define are: 

1) What to Buy

2) When to Buy

3) How Much to Buy

4) When to Sell

Happy investing!