Has Your Stock Portfolio Collapsed? Here's How to Plan Ahead...

Have you seen the recent Vodafone ZooZoo meme on the stock market? It's hilarious.

In the meme, the ZooZoo is shown to be depressed about his stock portfolio being down 40%. He is about to hang himself.

Just as he is about to do it, he gets a message on his phone. He reads the message and finds out that his friend's portfolio is down 60%.

Instantly, his mood changes. He starts laughing and swinging from the noose.

This is a humorous take of what many investors are felling right now in the market. But unlike the ZooZoo in the meme, they are not laughing.

Almost everyone's portfolio is down significantly. The only question is by how much. Those who had bought what they thought were the best midcap stocks and best smallcap stocks, have suffered the brunt of the carnage.

The midcap and smallcap indices have fallen about 20% from their peaks before the minor recent recovery. But many individual stocks have crashed 40% or more.

Unfortunately, these were the most popular stocks held by lakhs of retail investors all across the country.

It's not surprising that most retail investors have suffered heavy losses in the recent market correction.

The question now is all about what corrective action to take. Should you dump all your stocks and sit on the sidelines? Should you do absolutely nothing?

Let's look at the options before you...

#1 Do Nothing

This is usually the strategy of those investors who have high conviction in their stocks. They have chosen them carefully and willing to add more, i.e. buy on dips at lower levels.

They are not interested in buying any other stock because they believe the stocks they already have are the best.

If you are not this type of investor or if you don't have any such 'high conviction' stocks in your portfolio, then the 'do nothing' approach is not for you.

#2 Selective Gardening

Like most investors, you will likely have some out performers and some underperformers in your portfolio.

This approach involves getting rid of those underperformers.

Now, you may not know why a group of stocks, you thought were of good quality, are underperforming. But the market knows the reason.

If you are unsure if the fundamentals have changed for the worse, or you suspect that to be the case, then it's a good idea to exit. As they say, it's better safe than sorry.

The same logic holds for your outperformers. You may or may not know why they are outperforming, but the market does.

When almost every stock is in a downturn but there are some stocks near 52-week high, there usually is a very solid reason behind it.

You should consider holding on to these stocks.

#3 Dump Everything

We don't recommend this.

The reason why investors dump their entire portfolio usually boils down to poor stock selection. In other words they bought mostly bad quality stocks.

It makes sense to sell these stocks of course but before you do this make sure these stocks really deserve to be sold.

Take a re-look at their fundamentals. Are they getting worse? Ask these questions...

• Is a profit making company now reporting losses?
• Is growth slowing down fast?
• Are margins getting hit badly due to inflation?
• Are there internal issues, like the case of high employee attrition rates in the IT sector?
• Has the company made a major corporate announcement with which you are not comfortable?

Consider selling if the answers to these questions are 'yes'.

This Equitymaster editorial has more on the question - Should you sell your stocks now?

#4 Average Down

If the answer to the questions above are either 'no' or 'not sure', then take some more time to understand why the stock is falling.

It's likely that you've missed something. You might find the stock is not a sell candidate after all. And the market is punishing it too much unnecessarily.

These stocks are good choices to buy at lower levels, i.e. to average down.

But before you do so, ensure a very important point.

You must have a higher conviction in the stock based on objective data and logic than before you first bought the stock.

If you can't do this, i.e. your conviction is shaken or you found something that made you unsure about the future of the company, then it's better to sell even at a loss.

#5 Hit Refresh

Everyone makes mistakes. It happens. There's no need to beat yourself up over it.

Sometimes it's best to just replace your entire portfolio. Yes, this is a perfectly valid investing strategy.

If most or all your stocks are down a lot and you have lost your conviction in them, then why hold on to them?

Instead of the 'Selective Gardening' option mentioned above, which requires time and effort, you can instead choose to sell everything and just buy a new bunch of stocks.

This is different from the 'Dump Everything' option. Here, you are actively looking for new stocks to buy. The money you raised by selling your portfolio (or most of it) will remain in your trading account temporarily.

When you find new stocks, you will use these funds to buy them. You can also consider adding fresh funds in your account.

This approach comes with an in-built advantage. You can buy the most undervalued stocks thanks to the market crash.

Chances are, you will get a better margin of safety in your new stocks compared to your original group.

You can use the lessons learnt from your bad experience and turn it to your advantage.

Identify and shortlist the highest quality stocks - low debt or debt free, dividend paying, stable growth, good profitability, high return on equity, strong free cash flow, impeccable management - and ignore everything else.

Equitymaster's Stock Screener is a great tool for this.

Buy those stocks in this shortlist that have fallen for non-fundamental reasons, i.e. their fundamentals are still as strong as ever. The market will reward you in the long term.

Consider these 5 beaten down stocks to add to your watchlist.

So these are the options before you if your portfolio is down. In addition to the points above, keep these three important points in mind too...

• Don't start buying new stocks with fresh funds until you have decided what to do with your existing portfolio.
• Also, when deciding to sell a stock, think back to the original reason you bought the stock. Does it still hold or has the situation changed? This should guide your sell decision.
• Finally, don't buy anything you don't understand. If a company's business model is too complex, do buy its stock.

Happy investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...