How to Invest in Equity Mutual Funds During a Stock Market Crash

As of March 6, 2025, the BSE Sensex, BSE Mid Cap Index, and BSE Small Cap Index have corrected by 13.4%, -19.4%, and 21.6%, respectively. The mid-cap and small-cap segments of the Indian equity market are particularly feeling the heat of the market crash.

While mid-caps and small-caps have attracted investors due to their higher return potential compared to large caps, they are also more susceptible to downside risk. Keep in mind past returns, are in no way indicative of future returns.

Graph 1 shows that while the Sensex, which predominantly represents large caps has also taken a hit, the decline is much less over the same period than mid-cap and small-cap. This exhibits the stability of large caps.

Currently the trail P/E multiple of the Sensex and BSE Large Cap Index is around 21x, far lower than the P/E of the BSE Mid Cap Index and BSE Small Cap Index, which are around 32x and 28x, respectively (as of March 6, 2025)

Although the recent market correction has made valuations appear relatively reasonable in mid-caps and small-caps, they still cannot be construed as cheap.

The MidCap-to-Sensex ratio stands at approximately 0.51, noticeably above its long-term median of 0.45. Similarly, the SmallCap-to-Sensex ratio is around 0.61, also above its long-term median of 0.47 (as of March 6, 2025).

This indicates that the froth in the mid-cap and small-cap segments is yet to fully settle, and until these ratios drop below their long-term median levels, the margin of safety is not very comforting.

Although mid-caps and small-caps have high growth potential, the current valuations, make it imperative for investors to exercise caution and avoid chasing potential returns at unjustifiably high prices.

As you can see, India's Volatility Index or VIX - a measure of volatility - spiked soon after Trump's victory, reflecting growing concerns about his protectionist policies and their impact on global trade.

The equity market volatility can be attributed to a variety of factors including geopolitical tensions around many parts of the world, U.S. President Donald Trump's tariff threats, decreased hopes of a rate cut by the U.S. Federal Reserve, a weakening rupee against the greenback, relentless FPI selling, a slowdown in corporate earnings of India Inc., and so on.

Given the global and domestic headwinds at play, volatility in the near term is imminent and further drawdowns cannot be ruled out.

In such times, mid-caps and small-caps could correct further from the present levels. It is therefore important to approach investment by devising a sensible investment strategy rather than falling prey to panic selling.

Investment Strategy to Follow Now

The core & satellite investment strategy is a sensible way to deploy money into equity funds to address long-term financial goals and is followed by some of the most successful equity investors around the world.

Ensure that the core portion (65%-70%) of your equity mutual fund portfolio mainly comprises of some of the best Large Cap Funds, Flexi Cap Funds, and Value/Contra Funds for stability while you endeavour to create wealth over the long term.

The satellite portion (up to 30%-35%) of your equity mutual fund portfolio may include a couple of best Mid Cap Funds (max 2) and an Aggressive Hybrid Fund.

At this juncture, avoid adding Small Cap Funds unless you're a very aggressive investor with a stomach for very high risk, strong knowledge of these funds, and an investment horizon of over 8 years. Likewise, if your satellite portfolio already consists of some of the best Mid Cap Funds, refrain from making fresh investments now.

[Read- Decoding the Recent Market Correction: What's Behind the Fall in Mid and Small Caps]

The satellite portion of the equity mutual fund portfolio could push up overall returns. That said, it is important to keep an investment horizon of around 7 to 8 years for the satellite portion of the equity mutual fund portfolio.

Should You Opt for a Lump Sum Investment or SIP?

Investors having surplus cash could consider staggered lump sum investments. Given the imminent headwinds and volatility, staggered lump sums are more prudent than putting all your investible surplus at stake in one go.

If you are planning for long-term financial goals, Systematic Investment Plans (SIPs) would help you navigate market volatility as you systematically invest over a period of time.

As you may know, investing regularly through SIPs promotes discipline, averages out costs, reduces the impact of short-term market fluctuations, and facilitates wealth creation through compounding over the long term.

[Read: Why It Makes Sense to Take the SIP Route Now Amidst a Volatile Equity Market]

If you already have ongoing SIPs in some of the best mutual fund schemes, don't think about pausing/discontinuing them due to intensified market volatility.

The power of compounding works best when investments are held for the long term. Prematurely pausing or stopping SIPs puts a brake on this process and you may miss out on the opportunities.

Review and Rebalance Your Mutual Fund Portfolio

A mutual fund portfolio review helps you assess whether your current asset allocation aligns with your financial goals and risk tolerance.

If the market downturn has made you more risk-averse, or your asset allocation has changed significantly from what is best suited for you, review and rebalance your mutual fund portfolio.

Similarly, if your mid and small-cap holdings have underperformed significantly, you may want to rebalance by shifting some investments towards more stable assets like large-caps amid volatile times.

Reviewing your allocation would also help you ensure that your portfolio is well-diversified across different asset classes, such as equities, bonds, and other investment avenues.

To Conclude...

While market crashes can be unsettling, they also provide an opportunity to review and refine your investment strategy.

It is crucial to stay committed to your long-term goals and avoid making impulsive decisions such as discontinuing your SIPs.

It would be wise to set realistic return expectations and ensure that the schemes you hold align well with your risk profile, broader investment objectives, the financial goal you are addressing and time in hand to achieve those goals.

Be thoughtful in your approach.

Happy investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.