Investing in Share Market - 6 Basic Rules for Beginners
X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2019 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Investing in Share Market - 6 Basic Rules for Beginners

The stock market has fascinated people for over a century now. Stocks are even seen by many as the quickest way to get rich. However, there are indeed very few investors who see the stock market and stocks in the right perspective. To most, these are just tickers of prices going up and down. If your ticker goes up, you make money. If it goes down, you lose. That's both the start and the end of the story.

But the thoughtful investor is more discerning than that. He looks at stocks not just as quotes going up and down, but as real, live businesses in action. Go one step further and one realize that stocks can be one of the most fabulous asset classes to invest in. They are a vehicle and mechanism that provides ordinary individual investors with some amazing advantages and opportunities. Advantages that are unparalleled by any other asset class.

Are stocks the easiest way to build wealth?

Here are six reasons why, if you've not invested in stocks yet, you will definitely want to start this year:

  • Opportunity to own an existing business: When you buy a stock, you get to buy a stake in an already existing business with the huge advantage that business already has all its employees and infrastructure in place, and is already up and running. You straightaway get a claim on the businesses future profits (in your proportion of ownership) without any of the headache or effort involved in running it.
  • Liquidity: Buying stocks, you instantly rid yourself of all the above problems. You can instantly buy and sell your stake in the business with a single phone call or a few clicks of your mouse.
  • An astounding number of choice: You can buy only if you really like something. It would be a truism to say that you will try to find the most profitable business being sold at the cheapest price. But the point is that the stock market puts you in a position where it enables you to make such a choice.
  • Little money required: Think about this. Even if you plan to start a small grocery store in your neighborhood, you will have to stake a substantial amount of money on the success of just one venture that may or may not take off as planned. Compare this to buying a stake in a business in the stock market. You can get a piece of the action with even just a few hundred rupees, let alone lakhs and crores.
  • No hassles of negotiations and brokerage: With stocks, the price is right there for you to see. No hassles of negotiating with the opposite party. The brokerage is usually pretty low too (usually a maximum of 0.5%). This helps ensure that a substantial part of your investment is not eaten up by frictional costs.
  • The prospect of a higher return: One thing at the very core of choosing to run a business instead of investing your money in a bank fixed deposits the expectation of higher returns on your investment. Thus, businesses usually strive to earn returns much higher than your run-of-the- mill investments. The trick is to buy a stock that has shown that it can accomplish the above with reasonable certainty, and to buy it at a good price.

But is the Stock Market a Good Place to Invest These Days?

The stock market is like a maze. You need a blueprint to navigate it successfully. Without a blueprint in hand, investors must rely on hearsay. Usually, from other uninformed investors. It's a case of blind leading the blind! And none of them even recognize they're lost.

This is the worst way to invest in the stock market.

There is a better way.

You must first find a successful, tried-and-tested blueprint for stock investing. Spend some time understanding this blueprint. Then, and only then, take the plunge.

You need to know what to do. You need to know how to do it. You need to know when to do it. Only then can you expect to make money in the market, and keep it too.

It's Time to Go Back to The Basics!

Investing: All's in the process

With the Indian stock market at their volatile best (or worst), these are indeed difficult times for investors. At every rise, participants take the opportunity to book profits, with sentiment being as yet apprehensive. In such times, what could be the best strategy to use as a long-term investor?

We run through a brief process of investing here. We are of the firm belief that if by following a disciplined process of investing, you can accumulate significant wealth over the long-term.

  1. Assess your time horizon - are you a trader or an investor?
  2. If you are an investor, do you have the patience and the ability to keep emotions in check?
  3. Have you done your homework before investing your hard-earned money in stocks?
  4. Keep on following up...

The above is an indicative process to use while going about investing in equities. We certainly believe that it is necessary to invest according to a disciplined process, and this is the best way to make money in any market, bull or bear, across economic and market cycles.

What are the factors that longer-term investors must look at while taking an investment decision?

Business model

Undoubtedly, the very first thing that any investor must look at is the business/sector that the company operates in.

Management

The management is another extremely important factor to consider before investing in any company. At the end of the day, it is the management that will be the driving force behind the future direction and success (or failure) of the company.

Competition in the industry

The company's competition is another major factor that you as an investor should look at before deciding to buy (or not to buy) that company's stock.

Financial analysis

This, of course, is one of the major factors that most investors already look at. It includes doing a detailed study about the company's financial position and performance over a reasonably long period of time. Such a study is commonly known as 'fundamental analysis'.

Dividend yield

Dividends are a form of income from shares and regular dividend-paying companies do provide some comfort that their profits and cash flows are stable enough for them to keep paying dividends each year.

Value

And finally, the last step in deciding whether or not to buy a stock - the valuation phase. While the business model, management, fundamentals, and market positioning of the company may be the best, if the stock is trading at valuations that are unwarranted, then it is not worth buying the stock.

At the end of the day, we believe that investing in shares is all about conviction - if you are not convinced about the company, then do not stake your hard-earned money.

But, where can I gather information from?

You have probably received stock tips and recommendations from your brokers, friends, and family. Often, when asked for the rationale behind his decision, the person makingthe recommendation would state the source of the tip as some 'reliable' source. Investors make decisions based on certain factual information. Subsequently, they make future assumptions based on, and in support of, those facts. As such, knowing how an industry and a company functions is very important. In addition, it is equally important to gain such information from proper and reliable sources.

We present here a basic idea of where you can go about looking for information on companies you wish to invest in:

Sources of information on companies

  1. Offer documents: One of the best sources for understanding a particular sector or industry is the offer document of the company, if one can get hold to one.
  2. Annual reports: In case you cannot get hold of the company's offer document, given that the company has been listed on the stock exchanges for long, the annual report comes in handy.
  3. BSE/NSE announcements and company press releases: Apart from annual reports, it is the official company documents such as press releases, announcements, and presentations which are released in regular intervals. The source for such information is the BSE or NSE websites and the company's website.
  4. Business dailies and other media: Newspapers and news channels are a great medium for gaining updates on companies. Interviews with managements provide good information on the company's views, plans and strategies.
  5. Equitymaster database: You can also visit Equitymaster's database by clicking on this link. Here you will be able to view information relating to companies' historical numbers and business profile. You will also be able to view reports on key sectors.

Do Your Assets Match Your 'Need Hierarchy'?

An individual's Asset Allocation needs to ensure that the most important and most basic needs of his family are taken care of in the most secure manner. And what better way to do this than to invoke the hierarchy of needs theory by the famous psychologist Abraham Maslow? People familiar with his work would know that his need hierarchy pyramid ensures that our most basic needs are given topmost priority.

Asset Allocation

The bottom of the pyramid denotes the means to satisfy most basic and elementary needs. As one moves up the pyramid, elementary needs being taken care of, once can afford a slightly higher risk profile to seek better returns to satisfy tertiary needs.

What Will Keep Your Wealth Intact?

There are different asset classes that help individuals safeguard and grow their wealth...provided the allocation is as per the individuals' risk appetite. We suggest the following allocation keeping an average investor in mind.

  • Cash - It a good idea to keep cash in hand to buy good bargain stocks in the event of a market collapse. As such investors could keep about 10 to 40% of their portfolios in cash.
  • Gold - Having at least 5% of your assets in gold will give you that insurance policy that will protect your portfolio when things go bust.
  • Property - Property will ensure that when times turn bad, most of your income does not go towards meeting the EMI expenses on your loan. Clearly, there's no bigger relief than watching the roof on our heads become debt free.
  • Bonds - To protect your wealth against inflation and to earn a fixed rate of return, it is worthwhile having debt instruments in your portfolio. It helps you get the assured returns while taking on lower risk as compared to stocks.
  • Safe stocks - Finally, we come to stocks. Not just any stock, but safe stocks. These are stocks that have strong fundamentals and capable managements.

Such stocks can be found in every category of market capitalization -large caps, mid-caps and small-caps. The important point to remember here is the risk profile of each category.

As your experience will tell you, stock markets tend to be very volatile. And putting too much money in a single stock or sector can be very risky. Based on their relative riskiness, we have created an asset allocation pyramid that can help you in deciding how much money you should invest in a stock. However, it must be noted that the allocation levels could differ from person to person depending on individual risk appetite.

Setting the Foundation for Equity Allocation - Portfolio Building with Large Cap, Mid Cap and Small Cap Stocks.

Now that you have understood the basics of investing, we can get into the more specific need of building a portfolio that fits your needs. Along with keeping your risk appetite in mind, it is firstly important to identify your age factor, earnings, and objectives for creating wealth. Keeping in mind that we can't have a 'one-size-fits-all' strategy, we have discussed broadly the different and necessary key assumptions required towards an investor:

Being single

As the old saying goes, what the wise man does in the beginning, fools do in the end. When you're young and without a care in the world, life seems perfect. If you haven't crossed the 30 mark, and are still single, planning for your retirement or even your future seems a distant thought. But wise are those who start planning from the start!

Life as a singleton is often a lot more carefree and individualistic. You tend not to think of additional responsibilities such as kids, housing, schooling etc. It's all about working hard, partying harder and living it up. But somewhere reality sets in and that's when you start preparing to plan for your future.

Asset allocation portfolio for a singleton
  Single
< 30 years 30-45 years 45-55 years > 55 years
Carefree Building Wealth Adding To Wealth Carefree Retirement
Large cap 70-80% 60-70% 70-80% 80-90%
Mid cap 5-10% 10-15% 10-15% 0-5%
Small cap 5-10% 10-15% 0-5% 0-5%

Two's company

There are those who enjoy their single status in life, and then there are those for whom life is about having someone to share it with. Sharing joys and sorrows, sharing health and wealth, it's all become about being a couple for some. This is also for those DINKs... Double Income, No Kids.

Asset allocation portfolio for a person who is married and has no kids
  Married- No kids
<30 years 30-45 years 45-55 years >55 years
Property Top Priority Building Wealth Planning Retirement Carefree Retirement
Large cap 70-80% 60-70% 70-80% 80-90%
Mid cap 5-10% 10-15% 10-15% 5-10%
Small cap 5-10% 10-15% 0-5% 0-5%

Family matters

There is a famous line - 'Small family, happy family', but where exactly is that line drawn today? Would it end at being a happy couple, or would it end with the proverbial husband-wife-and-child scenario? If we were to go by the population of India, it would most definitely be a family inclusive of kids. Yes, there are the rare exceptions to the norm, but on an average the idea of a happy family consists of a set of parents with 2 kids.

Asset allocation portfolio for a person who is married with two kids
  Married-2 kids
<30 years 30-45 years 45-55 years >55 years
Property Top Priority Planning Children's Future Property For Children Retired/Children On Own
Large cap 70-80% 50-60% 70-80% 80-90%
Mid cap 5-10% 25-30% 10-15% 0-5%
Small cap 5-10% 5-10% 0-5% 0-5%

Conclusion

There's a saying "Boulders we cross, it's the pebbles that we stumble over". That is exactly what happens as we strive hard to build our wealth. We work hard, scrimp, save, make adjustments, and finally save money - for us, our dreams, our children and their dreams. Somewhere, however, we are so busy trying to survive in our race against time that the money we work so hard to earn is invested quite quickly, without giving it the thoughtful consideration due -'are our investments in tandem with our current and future needs?' This is where the mantra of asset allocation comes handy.

Asset allocation ensures that our expectations from our investments, our dreams for our future, and the way we invest money are all in sync with each other.

Reference:

The Investing Process With the Best Possible Returns

Buffett did not become a billionaire following the herd but by following his process... Read More

Is the Stock Market a Good Place to Invest These Days?

Everyone these days seems to think that the stock market is nothing short of a 'money factory'. Here's what we think of the markets... Read More

Approximate vs Precise: Which Is Better in Investing?

In investing, why you should trust Mr Approximate more than Mr Precise... Read More

Are you waiting for the perfect time to invest?

In this edition of the 5 Minute Wrapup, Equitymaster discusses why trying to time the share markets is a mistake every investor must avoid... Read More

What makes stock markets move?

In this edition of the 5 Minute Wrapup, Equitymaster discusses a crucial factor that is instrumental in market rallies and collapese... Read More

What is your investment criterion?

"You don't make money by investing in a good company. You make money by investing in a company that is better than the market thinks," wrote Warren Buffet in one of his letters to the shareholders of Berkshire Hathaway. Deciphering the performance of a company and predicting its future prospects requires 'analysis'. In light of this, we had asked our investors as to which technique of analysis they adopt for making their investment decisions. While a majority (54%) relied on fundamental analysis... Read More

Understanding Equities - Large Cap, Mid Cap and Small Cap Stocks Allocation

In this article we discuss basics of investing, understanding market capitalisation and allocation between large cap, mid cap and small cap stocks... Read More

It's Time To Go Back To The Basics!

Learning the basics of stock picking should be the starting point for any investor. And that's why we have put together this unique resource, which promises to help you achieve just that!... Read More

Stock Market and Trading Education

We, at Profit Hunter, deal with stock markets & trading as a business. We have put forth some of our experiences that prepare our readers from the impending uncertainties... Read More

The Best Asset Allocation For Your Equity Portfolio

Strategic planning your asset allocation between large cap, mid cap, small cap and other asset classes at Equitymaster.com... Read More

Advertisement
  Multibagger Stocks Guide
(2017 Edition)
 
   
  In this report, we reveal four proven strategies to picking multibagger stocks.

Well over a million copies of this report have already been claimed over the years.

Don't miss it for anything.
Go ahead, grab your copy today. It's Free.
 

Get the Indian Stock Market's
Most Profitable Ideas

How To Beat Sensex Guide 2019
Get our special report, How to Beat Sensex Nearly 3X Now!
We will never sell or rent your email id.
Please read our Terms

MARKET STATS