investors After the pandemic started looking at equity markets to generate income as it displaced their primary source of income. This is reflected in the number of trading accounts that have almost doubled over the past two years. Also, the share of retail in trading volume has increased from 39% at the beginning of 2020 to 45% currently. What type of psychological concept is associated with the prevailing optimism in the market? FOMO Versus FOLO- Fear of Missing vs. Fear of Losing.
Let me explain it with a simple example; You are offered to gamble on the toss of a coin. If the coin shows tails, you lose Rs 100. If the coin shows heads, you win Rs 150. Is this gambling lucrative? would you accept it? The expected value is obtained as the probability times profit or loss. In this case, the probability adjusted result is positive because you stand to gain (Rs 75) more than you can lose (Rs 50), resulting in a net profit of Rs 25. However, many may still reject it as a fear of losing it. Rs 100 is more intense than the expectation of getting Rs 150, indicating risk aversion behavior. Now, what is the profit that you need to balance an equal chance for a loss of Rs.100? For most, 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 gains gets overshadowed by the fear of losing Rs.100. In both scenarios, the net probability adjusted outcome is positive for the person accepting the gamble. The same is happening with equity markets right now.
Markets go through different cycles. In early 2020, the fear of losing money and risk-averse behavior was very prevalent, leading to a market crash. After that, a resurgence in investor optimism prompted investor behavior to shift toward FOMO. Consider this year’s IPO market. For most issues, retail subscriptions have been much higher than anticipated because in an up-trending market one would lose more for fear of missing out on potential listing gains if the listing price is lower than the issue price.
Equities are benefiting from expectations of an economic recovery driven largely by fiscal stimulus with a focus on credit delivery, improving farm incomes and export attractiveness. Some other factors that indicate good are looming expectations of increased capital expenditure, foreign direct and portfolio inflows, lower cost of credit, and increased consumer spending as vaccines begin and economies reopen. These growth drivers are expected to help corporates improve their earnings. However, in the short term, some factors remain – the potential impact of a third wave, high inflation, and concerns around valuations. Investors should be mindful of drawdown potential coming from or exceed normal equity asset exposures, and should continue to evaluate these exposures to ensure that they properly balance risks.
How can investors navigate this period? Current market cycle creates multi-asset Investment A much more relevant approach to generate better risk-adjusted long-term performance. Assessing sufficient equity exposure in a portfolio to meet a certain investment goal is important because higher allocations can expose an investor to the risk of capital loss if the market is to correct. Investors can also consider diversifying equity exposure by investing in international markets. It helps hedge against rupee depreciation and provides risk-taking opportunities for various international economic and fundamental growth drivers in addition to Indian equities.
One should ignore the noise of the short term market and avoid falling into the trap of FOMO vs FOLO as it can have undesirable consequences on your investment goals. Rather investors should stick to their financial plan. Investors enter the market with specific goals in mind, whether it means retirement several years in the future or focusing on near-term aspirations like buying a home or second car. Whether the market is high or trough, your financial plan hasn’t changed much, and depending on your financial plan, your original portfolio choice may still be the right fit for your goals.
(The author is Associate Director, Capital Markets & Asset Allocation, Morningstar)