How Do Mutual Funds Perform During Market Crashes?

A market crash is the worst fear of any investor. Gains made over the years get wiped out in days, and portfolios go red. While nobody wants markets to nosedive, a crash is inevitable in markets, which go through cycles. Like other financial instruments, mutual funds are affected during a crash, and their performance takes a hit. How? Let's find out.

Performance of Mutual Funds During Market Crashes

NAV of Mutual Funds Come Down

NAV, or net asset value, is the unit price of a mutual fund. The value of your mutual fund holdings depends upon the fund's NAV. When NAV comes down following a crash, so does your investment’s worth. Let's understand it with an example. Suppose a fund's NAV before a crash is 50, and you have 1000 units of it. So, the value of your investment is ₹50,000 (50 X 1000).

However, following a crash, if NAV drops to 40, then the value of your investment drops by ₹10,000 to ₹40,000 (40 X 1000).

Stocks Take a Hit and So Do Funds

The underlying securities of mutual funds comprise stocks from different companies. Due to this, mutual funds offer you the benefit of diversification. However, during a market crash, stock prices come down.

This, in turn, pulls down the performance of mutual funds holding these stocks. Companies, too, face a tough time with their operations taking a hit, and it takes time for stocks to recover. Performance improves only when stocks recover lost ground.

Give the Benefit of Rupee Cost Averaging

While the performance of mutual funds during a market crash, if you are investing via systematic investment plans (SIPs), you reap the benefit of rupee cost averaging. It means you gain more units of a fund during a crash. Let's see how. Suppose you invest ₹1000 in a fund whose NAV before a crash is 10. In such a scenario, you get 100 units of the fund (1000 /10).

If NAV drops to 5 following a crash, you get 200 units of the fund (1000 / 5). This averages out the cost of buying with time. When markets recover, you benefit from acquiring these extra units at a lower NAV at the same invested price.

Approach to Mutual Fund Investment During a Crash

Don’t Panic and Exit Investments

Market crashes cause temporary declines in mutual fund values. Exiting during this period locks in losses, converting notional (unrealised) losses into actual ones. It's important to avoid impulsive decisions driven by fear.

Understand Mutual Funds Are Long-Term Instruments

Mutual funds are designed for long-term wealth creation. Short-term volatility is natural, and staying invested allows you to benefit from market recoveries over time.

Benefit from Rupee Cost Averaging

Continuing SIPs during a downturn helps buy more units at lower prices. This brings down the average cost per unit and enhances long-term returns when markets rebound.

Learn from Market History

During the 2020 Covid crash, markets fell by 38%, but many funds still delivered over 14% CAGR later. Historically, markets have bounced back faster than expected.

Patience Is Rewarded

Investors who remain disciplined during market volatility often emerge with stronger portfolios. Crashes, while unsettling, present opportunities for long-term wealth creation.

Stay Focused on Financial Goals

Avoid reacting to short-term market noise. Instead, align your investment decisions with long-term goals like retirement, education, or home purchase. A goal-based approach helps stay invested even in tough times.

Are Market Crashes the Time to Look for Multibaggers?

Market crashes can be a great time to scout for potential multibaggers. When markets fall sharply, even fundamentally strong stocks often get oversold. This creates a rare opportunity to invest in quality businesses at attractive valuations. Historical data shows that many of the top-performing stocks were picked up during downturns, when pessimism was high. However, not all low-priced stocks are multibaggers – careful research is essential. Look for companies with solid balance sheets, competitive advantages, strong management, and long-term growth potential. Crashes offer the ideal environment for patient investors to build high-conviction positions that could deliver outsized returns when the market recovers.

What Should Be Your Mutual Fund Strategy Amidst Crashes?

During market crashes, your mutual fund strategy should focus on discipline and long-term thinking. Avoid redeeming investments out of fear, as doing so locks in losses. Continue your SIPs to benefit from rupee cost averaging, which reduces your average purchase cost over time. If your financial goals remain unchanged, there’s no reason to alter your investment plan. In fact, if you have surplus funds, consider topping up your investments in diversified equity funds, especially those with a history of managing volatility well. Crashes are temporary, but compounding is permanent; staying invested through tough times often leads to superior long-term returns.

Summing it Up

As an investor, there's little you can do to prevent a crash and a subsequent plummeting of funds' performance. What you can do, however, is to stay calm and not exit your investment. By doing so, you give yourself the chance to benefit from the market rally and boost your wealth.