Trading account and your demat account and are perfectly poised to start off on your journey towards investing in equity markets. Remember, investing in equity is not as straight forward as investing in bank FDs and forgetting about it. It is a lot more complex and nuanced. There are some basic things to know before investing in stocks in terms of understanding the risk and return profile of equities. What to know about stocks before investing and how to apply these ideas in your practical investing journey. Here is a quick 10-point primer on things to know before investing in stocks..
1. Your risk appetite is most important. Don’t get carried away by the returns prospects in stocks or the kind of money that your neighbour made by punting in a small cap penny stock. Making money in stocks is not that simple as it is all about risk. What is your risk appetite? Can you take the risk of mid-caps; can you manage the volatility of cyclicals or are you better off sticking to defensives? These are basic questions you need to answer.
2. Diversify across stocks and time. You may hear stories about how someone in your office made a huge pot of money by putting all her capital in just one stock. As much as it sounds enticing, it could expose you to a huge concentration risk. As a measure of abundant caution, spread your risk across stocks. Also don’t try to buy all your target stocks at one point of time. If you phase it out, you can actually get a better price.
3. Often the best investment is the one you did not make. Sounds ironical right? Imagine that you almost put money in Gitanjali Gems or a Kingfisher just days before the real story emerged. You abstained just because your conservatism dictated otherwise. You are surely better off. Imagine if all your money was in any of these stocks?
4. Markets can be irrational longer than you can be solvent. What John Maynard Keynes said more than 75 years ago is still very relevant. Your view on the stock may be right but remember there is a point up to which you can be liquid and solvent. At that point your capital will have diluted and you will lose access to liquidity. That is what happened to LTCM in 1998. Then it does not matter if you eventually turn out to be right.
5. Always keep an exit route available to you. Don’t close your equity doors by taking a decision that does not have any exit doors. At times you may have to exit at a loss but that is part of the game. Never get into a situation wherein you cannot redeem your situation. It is OK to lose out on profit making opportunities, but conserving your capital and your future investing potential is the key.
6. It does not matter how often you get it right. So you got 80% of your calls right; but that hardly matters. It is what you do when you are right and what you do when you are wrong that actually matters. Exit your losing positions quickly and hold on to your winning positions as long as you can. That is more important than just being right or being wrong in the markets.
7. Don’t try to make money in the short term. The stock market is a slotting machine in the short run but it is a weighing machine in the long run. If you are playing the investment game in the stock markets, always play for the long run. Good stocks take time to give good returns. If you chase short term returns you are likely to be disappointed more often than not.
8. Play to your strengths; not to your weakness. This is a basic rule you need to remember before you start investing. There is a lot of common sense in investing so always invest in those ideas you are most comfortable. If you are not so techno savvy, there is no point in putting money in high technology stocks and artificial intelligence stories that you do not understand. We all have some inherent strength in identifying winners in the stock market. Stick to that core.
9. You rarely make profits on good dividend paying stocks. It is quite common for investors to look at dividend yields in the hope that these stocks will yield good returns. They rarely do! That is because, high dividend yield stocks are normally low growth stocks and the market valuation tends to reward growth more than regular income. For regular income you always have bonds and debt, so why waste time in equities. The theme is to focus on growth.
10. If you are going to be an active investor, better make it worth your while. At the end of the day, the proof of the pudding lies in the eating. Equities are volatile and so there are going to be up-cycles and down-cycles. But over a period of 3-5 years you should be making money. In fact, you should be making more money than what you would have made by investing in an index fund or in a diversified equity mutual fund. If that is not the case, then you are better off handing over your money to a fund manager and let them do the job for you!