How to handle volatility: Creating a mindset

I have often  found that for an individual investor, the toughest thing to deal with in stock markets is volatility. And by volatility – though it means fluctuations on both sides, what is tough to deal with is basically crashing stock prices. Financial theories have often equated risk to volatility – which may have some sense when you have a need to regularly evaluate the value of your portfolio, but is perhaps otherwise meaningless for an individual investor.

The all encompassing mindset of an individual investor has to be that of preparation for crashes. While investing in the stock markets, be it through mutual funds or directly, the dominant mindset needs to be that of being prepared for at least a 30% cut at any point in time. That mindset prepares you better to deal with it when it comes.

The advantage of such a mindset is to ensure some degree of rational thinking when the crash happens, even though there may be butterflies in the stomach. Inevitably that happens. In such a scenario, I have found the Ben Graham corollary of thinking of the stock market as an emotional guy called Mr Market whose moods keep fluctuating to be most valuable. This moody guy comes up everyday and offers you a price for your businesses. You are free to buy from him, or sell to him at that price whenever you want; and best of all, you are free to ignore him if you choose to. He will still come back tomorrow. Getting these two things into your mindset – that of expecting crashes, and thinking of stock markets as an emotional guy Mr Market – are the basic starting points in your battle against volatility.

Let’s say you manage to do that – the toughest task of all. After that, deciding what to do when stocks crash becomes easier. And that depends on largely whether you have a plan on why you are in the markets in the first place. If you have, then you are likely to do whatever makes sense according to that plan. If you do not, then this crash could be a good opportunity to do so. In both cases, you are likely to be in a better position to then decide whether to buy from Mr Market, sell to him or simply ignore him.